If there is one industry that has successfully resisted change, it is Venture Capital. There is no doubt Venture Capitalists (VCs) play a vital role in the capital markets assisting companies raise seed/growth capital to advance development programs. Major VCs devote significant amounts of capital from their Limited Partners (pension funds, endowments, foundations) investing in emerging growth companies following extensive due diligence by seasoned industry veterans, introduce valued networks assisting portfolio companies with operations, and facilitate successful exits (IPOs, M&A) given strong relationships with bankers and strategic buyers. For these services they are well compensated.
This sounds impressive. So what is the problem? Over the past 10 years VCs struggled to provide alpha (premium to established benchmark returns like the S&P 500) to reward investors for participation in a risky asset class. Though the recent IPO window and robust M&A activity will surely improve these metrics moving forward, many still feel the incumbent fee structures (“2” and “20”), long-term lock-up’s (~10 years), and reluctance to invest in early-stage opportunities and those companies located outside of San Francisco/Boston, is forcing companies to seek capital from alternative sources (accredited investors, family offices, limited partners direct).
Enter online venture capital
Fueled by advancements in social media (~Linkedin), passage of the JOBS Act (expanded shareholder cap and approval of general solicitation), and increased adoption of direct investing by alternative investors (i.e., Peer-to-Peer lending ~Prosper), the funding landscape is drastically changing! Whether in the consumer goods industry (CircleUp), technology (FundersClub and AngelList), healthcare (HealthiosXchange, Poliwogg) or real estate (Reality Mogul, SilverportalXchange) industries, investors are increasingly sourcing and investing in deal flow (private equity) directly. As with the discount brokerage revolution (rise of online public equity trading platforms including Schwab and TD Ameritrade), technology is altering the landscape of how investors participate in private equity.
One area where technology is reshaping the investment landscape is what many are calling “Convergence.” This term describes the merging of retail and institutional pools of capital resulting from the proliferation of online platforms including Peer-to-Peer Lending (P2P), and equity crowdfunding/direct investing (AngelList, Fundrise, Mosaic).
A recent article, “Has Peer-to-Peer Lending Turned Into Hedge Fund-to-Consumer Lending?” by JD Alois, Crowdfund Insider, highlights convergence:
- “While P2P lending started out by matching an individual borrower with an individual investor things have rapidly changed. The outsized returns generated by the various P2P platforms have not been missed by institutions and hedge funds.”
- “During the last quarter, almost 60% of the $1.1 billion in loans originated on California-based Lending Club – the largest P2P lender in the US – were snapped up by asset managers, banks, hedge funds, insurance companies, pension funds and other institutions. At Lending Club’s main competitor, Prosper Marketplace, 66% of loans went to these same types of investors.”
Though the merits of institutional capital’s involvement in the P2P industry can be questioned (hedge funds have acquired large portfolios of P2P loans and securitizing them to attain leverage), there is no denying the evidence supporting how technology is facilitating convergence between retail platforms and institutional investors.
It is just a matter of time until blue-chip venture capitalists launch their own investor syndicates. Why make this bold statement? Because the value propositions associated with leading investor syndicates are too compelling for Fund managers and professionals start-up investors to ignore including:
• Online presence to build a following
• Turnkey fund management tools to run venture funds (i.e. HealthiosXchange’s Reserve system)
• Access to a marketplace of tens of thousands of accredited investors
Convergence is on the move. Institutional capital is “crowding out” retail capital (Peer-to-Peer), strategic buyers are moving online to meet promising emerging growth companies, and venture capital firms are launching investor syndicates to tap into additional sources of capital. Catch the wave!
Image © CanStock / tashatuvango