Mod Note (Andy): Best of Eddie, this was originally posted in October 2013.
The venture capital business has gone through a lot of changes over the past decade. Most recently we've seen regulations implemented that give regular Joes access to deals only institutions and accredited investors could touch previously, and the swelling ranks of Dot Com and Web 2.0 millionaires (and billionaires) have elbowed out a lot of traditional venture capital shops.
That trend looks like it's only going to continue, and the latest proof of that is the expanding role of angel investors in the startup ecosystem. To wit: AngelList is offering a new program called AngelList Syndicates, where successful angel investors are no longer constrained by their own net worth. By allowing angels to pool their resources into a unified fund, they're about to have a profound impact on the way venture capital is deployed from here on out.
At the heart of the matter are the fees. As in, there are none. Angels get to kick in their money and invest in companies fee-free, and don't have to worry about paying anything until they get an exit. VCs get paid (typically) much like hedge funds with a 2 and 20 model. So they make 2 points a year just for showing up. That adds up quick.
Exit fees are basically the same. Where a VC fund would take 20% on the way out, the lead member of an AngelList syndicate takes 15 points and another 5 kick back to AngelList itself.
The other advantage angels have over the big VC funds is access to deal flow. VC funds need to deploy big money, which is why you never hear of them kicking in a $100,000 investment so a hot new startup can Rackspace some servers and change the world. That's the purview of angels. And some big name angels are leveraging that access right off the bat.
Jason Calcanis is not a guy I particularly like, but I have to admit a grudging respect for him. And he's got AngelList Syndicate wired. So much so, that he's able to offer startups up to a million dollars over a Hackathon weekend. Let that sink in a minute. You show up at a hackathon, code something really cool, and walk away with a million bucks two days later. That's stout.
One thing the Internet has done pretty much since Day One is squeeze out the middle men. I saw this firsthand as a stockbroker. We used to make bank; now brokers might as well be asking customers if they want fries with that. Then bid-ask spreads tightened across the board. Then fractions became digits. All in an effort to make things cheaper and better for investors.
This is no different. Will there still be big VC firms who ring the register? Sure, of course there will. But there won't be many little ones anymore. Think about it: if an AngelList syndicate can put together $40-50 million, why would you ever go VC?
Here's where a Liberal Arts education just might trump a STEM background....
I'll explain: the fund structure is one of the oldest risk-return models in existence. It basically dates back to the year 1000 AD with the maritime republics like Venice,Genoa, Amalfi... While most of Western Europe was starving, these tiny Italian maritime city-states flourished thanks to a relatively simple fee structure for high risk investments.
The "Contratto di Commenda," as it was called, basically offered wealthy merchants (read Limited Partners) the possibility of making high returns by pooling their capital with a ship's captain (read General Partner) and finance a trade voyage to sell to the eastern Mediterranean and return with rare spices and fine cloth, among other wares. They did this risking their own capital, but not wanting to risk their own skin (read limited liability) These voyages were difficult to organize and very risky (bad weather, pirates, creditors, and the fluctuations in prices of silk and pepper). They took time to travel, trade, and travel home. They often took 10 or more years as the typical voyage (read venture investment). Most VC funds have a ten year (+ 2) duration from organization, deployment, management, exit to distribution.
When, and especially, if the ship returned, profits were divided thus: 80% went to the wealthy merchant investors (LP's); 20% went to the ship's captain for organizing, managing, and most of all, risking his skin and using his unique skills, knowledge, and balls to pulling it off. Of course, a crew had to be engaged to manage the day to day business of the ship, fighting pirates, trading with foreign merchants, exacting payments, record keeping, etc. The "Contratto" provided for a 2% annual payment to cover the costs of managing the voyage from origination to exit, and liquidation (read Management Fee).
I personally found this fucking amazing. Especially when you negotiate the terms of your fund, you will find that despite bubbles, crisis or wtf else the 80-20-2 structure has been around for more than a 1000 years. Guess theses Italians nailed the perfect fee structure for high risk ventures.
What we have today is nothing new. The 70's and some part of the 80's had relatively small pools of capital in silicon valley. When $100 million dollar funds appeared by the late 80's and early 90's, the institutions (CalPERS, and of course government intervention as a result) had moved in. Personally, I think billion dollar venture capital funds are a scam. They're playing paintball with artillery, and losing.
A guy from Sevin-Rosen (they funded Compaq-the first IBM PC clone) told me that VC rankings and institutional MBA run pension funds would kill the goose. He wasn't that far wrong. Maybe the Angels are just resetting the game.