Digitising Venture Capital

Venture capital has been a go-to source of funding for several digital projects across the world. Over the last few years, we have seen many models emerge to take VC to the masses. From crowdfunding platforms like Seedrs and crowdcube, to platforms like Angel List, there have been several successful models that have moved VC closer to the retail investor. Yet, much remains to be done to get VC global, nimble and democratise this asset class.

In a recent tweet from Romeen Sheth, where he was quoting David Sacks; they highlighted that Silicon Valley was a way of doing business, not just a place of doing business. I agree, and I would even go further to call it a model that can be used to groom and mature a technology ecosystem. Cities like London, Bangalore, Tel Aviv and more recently, Jakarta, Nairobi and Lagos are practically replicating the Silicon Valley model to create a startup ecosystem. The tweet also highlighted the mix of Risk Capital, Skills and support that is necessary to create ‘a Silicon Valley’ successfully.

As a particular ecosystem starts to show green shoots, risk capital arrives. Skills are often borrowed or reverse brain drained from more mature ecosystems. For example, in India the first batch of entrepreneurs who created Infosys and Wipro were the green shoots; the second batch of entrepreneurs created Flipkart and PayTM. By this time more risk capital had arrived; sourcing talent from local top institutions like IITs and IIMs or from the Ivy League became the norm. Such talent being part of the management team even became an eligibility criteria with many VCs. The early batches of technology entrepreneurs provided the necessary indigenous support to the system. Thanks to the 'Silicon Valley' model, we now have the fourth or even the fifth wave of entrepreneurs coming through. Indonesia is going through this cycle now, with their second batch of entrepreneurs graduating (IPOs and Exits).

I am sure we will see this story/model repeated time and again in other exciting innovation hubs of the world like Lagos and Nairobi too. Yet, there is much more to be done to make the VC world more efficient. First time fund managers still struggle to attract capital from institutional investors. The asset class suffers from its inability to offer liquidity to its investors. Access and ability to invest into top funds is limited to a selected few who can afford large ticket sizes. Can these pain points be addressed systematically and solved at scale? I believe so.?

Redefining venture capital through digital securities could be a solution to several of these pain points. In my previous post about democratising capital markets, I had touched upon attributes of digital securities that help create a more inclusive model. I reached out to?ADDX?team for their feedback on this topic too. As practitioners in digitising venture capital funds, they were able to provide practical insights on how their platform dealt with these pinpoints.

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How do you structure a VC fund within your platform?

We incorporate a special purpose vehicle (SPV) through which?ADDX?platform investors will be investing in the VC fund. From the VC fund manager’s point of view, the SPV is the LP, and the VC fund does not deal with the fractional?ADDX?investors. And so, the minimum investment amount only applies to the LP – that is, the SPV.

?ADDX?will then fractionalise the investment and offer digital securities in token form to?ADDX?investors. The minimum investment will typically be USD 20,000. Compared with the USD 5 million investment for LPs, this is a 250-times reduction in minimum size.

?What are the pros and cons for the investor?

Investors do have to put in all the money up front. In other words, from the point of view of the token holder who is investing USD 20,000 or more, 100% of funds are called in Year One. This is to avoid the complexity of having to call for funds in Years Two and Three. This does mean investors face a small reduction to their IRR. This is because in the 40-30-30 calling schedule scenario, other LPs would have held on to 60% of their money until Year Two and 30% of their money until Year Three, and they would have earned some cash management returns in that period. The small reduction to IRR is the trade-off fractional investors accept for getting access to VC fund investing.

However, there is one major benefit extended to investors that is not available to big investors or the LPs of the VC fund. It is the opportunity to trade their tokens on the secondary exchange. They can do so at any time throughout the 10-year fund tenure, as long as there is an investor willing to buy the tokens from them – our blockchain-powered exchange matches bid prices to ask prices, just like any securities exchange. And there is no minimum amount required for a trade to go through – it could happen for USD 1 worth of tokens. That is, you are allowed to sell a fraction of your USD 20,000 investment.?

We are making two significant changes to VC fund investing that changes its risk profile significantly

First the fractional size means investors can take on the amount of the investment appropriate to their portfolios. As long as the investment is right-sized, everyone could potentially contemplate participating – because you can limit the risk to what makes sense for your overall holdings.

?The second change is secondary trading. This significantly reduces your risk, because once the investment has met your objective or if there are changes to your investment goals, you can choose to cash out. Ten years is a long time. It’s not a long time for a pension fund or a sovereign wealth fund. But it is a long time for an individual. The chance to exit helps make the investment more risk-managed for individuals.

How is your platform different from current options in offering liquidity for investors into VC funds?

VC funds typically publish their NAVs quarterly or semi-annually, so the NAV serves as a price guide for those who want to trade tokens. Secondary trading is a major benefit that?ADDX?token holders get vis-à-vis the big LP investors. LP investors can only buy and sell over-the-counter. And not only that, they also need the VC fund to approve any sale. VC funds are typically very reluctant to approve such sales, because of complicated factors such as KYC, whether the buyer is domiciled in a jurisdiction that allows him to make the purchase, etc. There are many legal checks and paperwork that need to happen, and these processes have to be carried out manually

How do digital security platforms help in globalising access to venture capital for investors?

For the VC fund deals on?ADDX?so far, we have used an SPV incorporated in Singapore. And so, as long as the VC fund can solicit investments from a Singapore LP investor, the investment will be compliant.

?The fractional investors can come from any country that?ADDX?is allowed to onboard investors from. At the moment, we are able to onboard investors from any country in the world except the US. We currently have investors from 27 countries, spanning Asia Pacific, Europe and the Americas. They do have to be accredited investors.

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These details furnished by?ADDX?on how VC funds are structured on their platform, offers us two key levers that can make the asset class extremely attractive. One, is the ticket size - imagine being able to participate in a $1Bn Deep tech fund by A16Z with $25000. Two, is the secondary exchange - this is clearly a massive gap in the VC industry that has needed addressing.?

On that note, I really hope these digital platforms become the primary distribution launchpads for VC funds in the next decade or so. Interesting times we live in - watch this space.