Early morning thoughts on Democratized risk capital…

“…what caught my eye this morning on a WSJ blog post is the emergence of online angel groups, known as angel syndicates. Syndicates have of course been around for a long time, but goalposts have been moved. A lot. The subject under discussion is the extent to which these angel groups are changing the rules and process of conventional angel investing.”

Like most investors, I am aware of the recent easing in the government’s long-standing restrictions on fundraising. Entrepreneurs are celebrating, pointing to a bright new future when anyone with $25 can support a start-up company. Venture funds are voicing concern, highlighting the very real probability that a lot of money will be lost (conveniently ignoring the fact that “professional” venture investors are perfectly capable of losing staggering amounts of capital, thank you very much). And investors are cheering the emergence of angel markets.

Enough ink has been spilled debating sites like Kickstarter and Crowdfunder, so I’ll not add to that dark ocean. Instead, what caught my eye this morning on a WSJ blog post is the emergence of online angel groups, known as angel syndicates. Syndicates have of course been around for a long time, but goalposts have been moved. A lot. The subject under discussion is the extent to which these angel groups are changing the rules and process of conventional angel investing.

First, a data point, hoisted directly from the WSJ post: “When entrepreneur Jakub Krzych raised seed funding for his first technology startup in 2009, it took him around six months to scrounge together $20,000. A few weeks ago, Mr. Krzych rounded up $250,000 in just three days for his second startup, called Estimote.”
If that single paragraph doesn’t set your early-stage investor’s heart racing, you aren’t paying attention.

What changed? The new rules eliminate a ban on “general solicitation”. Entrepreneurs can now publicly market their fundraising efforts on social media or syndicate services which have tens of thousands of potential backers. The result? Rapid acceleration and expanded scope for seed-stage capital aggregation, made possible by the entrepreneur’s new-found ability to assemble angel groups over the internet.

Typically, a syndicate works like this: A person or firm forms a group that individual investors can join. These individuals select how much they want to contribute, while the leader of the syndicate decides which of them to accept or reject. The syndicator will typically stake a claim on future profits of the deal (much like a conventional venture investor), but won’t receive a management fee. A syndicate can be formed for a one-time deal or for multiple investments, and backers get access to the syndicator’s deal flow.

What might go wrong? Plenty. Some of my friends in the Bay Area venture ecosystem worry that the rise of syndicates could help fan another investing bubble, inflating valuations and compressing angel-round returns (which can be depressingly small in the first place). A class of investors without the experience or knowledge to understand the risks embedded in seed-stage investing may lose their money. Worse, they may be fleeced by charlatans. Early-stage investing is already a high-risk game and professionals lose way more often than they win. There has been talk about stiffening the rules once we get a sense of how the game has changed. And my, how it has changed. The best analog I can think of is the de-regulation of fixed trading commissions in the early 1970’s, which gave rise to the discount broker and which fundamentally altered the revenue model for Wall Street… with both positive and negative ramifications. While traditional venture will still be an important part of the early-stage investing landscape, syndicates could disrupt the clubby world of angel investors and could give comfort and guidance to those (responsible?) aspiring angel investors who need someone to hold their hand when committing capital.

Of course, this doesn’t mean the deals themselves will have a higher probability of working out. It just means that you’ll have someone to drown your sorrows with after the deal hits the pond.

But why am I writing about this on an impact investing blog?

I have heard more times than I can count that crowdfunding is, by definition, an impact investing issue. I want to be 100% clear on my opinion: while I sympathize with those who claim this is a pure-play victory for impact investing, I disagree. To me, capital aggregation structure is a regulatory issue, not an investment discipline issue. Saying that unfettered crowdfunding is purely an impact story is like saying that ending subsidies to oil companies is purely an impact story. True, crowdfunding offers derivative benefits to the impact investing community. And true, it offers the benefit of disproportionally awarding efficiencies to impact entrepreneurs and investors. But while I am hugely enthusiastic about the potential for the discipline, this enthusiasm does not blind me to the fact that non-impact businesses will also benefit.

But just as an impact investment in not an intrinsically more worthy recipient of capital (from a purely financial perspective) than a conventional investment, a crowdfunded company is not inherently more likely to succeed than a conventionally-funded company. Full stop.

HOWEVER… The rules around capital aggregation have clearly changed. And I think that this change will disproportionally benefit impact entrepreneurs. Why? Because, while it is always a demoralizing siege to raise start-up capital, social and environmental entrepreneurs have an even harder time than most. This is true because the notion of generating environmental and/or social value is still an unfamiliar proposition. Early stage investing is scary enough without adding to the uncertainty with innovative business models, progressive language around measuring “return” differently, and talking about responsibility to stakeholders beyond equity holders. So, is this an “impact investment story”? I’d say yes, but for two narrow reasons:

First, democratized access to capital aggregation this permit like-minded groups to gather capital quickly and efficiently for specific companies, or groups of companies (I would suggest to the leaders of TONIIC, Investor’s Circle and Social Venture Network that launching an online angel syndicate would not be a waste of time, and might solve some of their funding issues). Which in turn will permit impact-oriented seed-stage entrepreneurs to spend their time operating their businesses, rather than raising capital. Which in turn will increase the probability of a successful outcome.

And second, because impact investing is still very much about innovation. Innovation is risky. It involves failure. It involves testing theses, building businesses, learning from our mistakes. It requires risk capital that can absorb these losses in pursuit of better understanding of what works, and what doesn’t. By lowering the bar for minimum investment levels, by opening the door to passionate impact investors, by offering one solution to the problem of scalability for due diligence and by bringing together experienced angel investors with enthusiastic beginners, I think that this change has the capacity to fundamentally alter the funding dynamics for early-stage impact entrepreneurs.

Now, how do we build a similar funding exo-skeleton to bridge the gap between early-stage impact capital and expansion impact capital… Watch this space.