It’s the end of VC as we know it
The tokenization of private company investment has arrived — and we will all be happier because of it.
As Joey Krug, Co-CIO of the pioneering crypto fund, Pantera Capital, recently announced in his Crypto Thesis, ‘Blockchain tech and cryptocurrency are the underpinnings of a new financial infrastructure.” And yes! This disruption also confronts all the money-managers (a.k.a. as VCs) on Sand Hill Road who can be spotted washing down their nosh with $22 glasses of Napa’s finest varietals at the Rosewood Hotel.
For the purpose of this opinion piece, I am not going to pretend to be a partner at Silicon Valley legal powerhouse, Wilson, Sonsini, Goodrich & Rosati, or q free-wheeling cap table jockey at Morgan Stanely. I know all those folks, and I would never, ever try (nor do I wish) to practice their trade. My goal here is to offer a more existential view. That is, what do private company stockholders — most importantly company founders and angel investors — really want?
Note: I have embedded in this post two recent and very comprehensive slide presentations on the state of security tokens for further research and detailed explanation.
Back in the 1960s, when Bill Draper, Tom Perkins, and Art Rock were pioneering the modern venture capital world, entrepreneurs were happy just to get some money to build their science projects, and the VC OGs were happy to have a little spare cash to put dinner on the table while their spouses tried to figure out what they actually did for a living. The VC business, of course, has gotten much bigger and more institutionalized. The money managers are now able to live handsomely off fat “management fees,” play a lot of golf, and patiently wait for the final sunset in their fund’s “10-year horizon.”
The problem is the risk vs. reward economics have not improved for entrepreneurs and the angels who back them and, in fact, have arguably gotten worse. The tokenization of the VC business is going to change all that and put an equitable share of the rewards back into the hands of the folks that take most of the personal risk and do all the work.
Avoiding the equity ‘washout’
As investments in VC funds grew into the billions, most VCs stopped doing seed deals because they had to put their “money to work.” What they really meant was they wanted to leave all the early-stage investment risk in the hands of a whole new generation of “angel’ investors who are primarily successful entrepreneurs whose investments are more driven by joy in championing entrepreneurs than pure ROI. But when you interview many of these early bettors, they will all have stories of how they got “washed out” by the VCs who take advantage of strategic pivots and tight situations to “re-capitalize” the company. Entrepreneurs often face the same situation.
By their very nature, entrepreneurs put all their eggs in one basket and happily battle on with pride in their mission to make their company’s dream come true. Along the way, many founders get booted, washed out, and left out to hang — even as the company they founded might go on and achieve great success.
The tokenization of VC will not eliminate these risks for entrepreneurs and angels, but it will at least reasonably mitigate the risk.
The tokenization of assets
When referring to the tokenization of VC, I am not talking about the non-equity backed “Altcoins” and their “Initial Coin Offerings” (ICOs). I am talking about the creation of smart equity tokens (a.k.a. Security Tokens) which are fully SEC-compliant. A core group of angel investors, entrepreneurs, as well as established VCs like Draper Associates, Andreessen Horowitz, and Lightspeed, now see the strategic value of smart equity tokens, because they essentially allow stakeholders to control all aspects of their equity ownership programmatically.
When you add it all together, tokenizing VC will “eat a lot of paper” by automating the SEC compliance process, including investor eligibility, disclosures, and communications, cap table management, and enforcement of investor rights. Most of the top Silicon Valley law firms have now followed the early legal pioneers like Perkins Coie and DLA Piper and are now helping companies tokenize their fundraising process, and may well be automating themselves out of business.
Smart securities essentially utilize blockchain technology to help private companies expand the investor base, create early liquidity options for angels and entrepreneurs, reduce overall investor friction. By fractionalizing equity ownership, even the wildest dreams of ‘democratizing investing” conjured up by early crowdfunding pioneers like AngelList’s and StartEngine 1.0 are finally being realized.
Not surprisingly, both AngelList founder Naval Ravikant and StartEngine founder Howard Marks both pivoted their crowdfunding initiatives into the token world, and are both powering STO networks. “It was a shift in the market I would never have predicted, but I feel lucky it happened,” admits Marks.
The emergence of new investor classes
Ultimately, smart securities will enable fractionalized ownership of the real estate, debt, most equities, and precious metals. In total, as seen by the image below, the transitions to the tokenization of assets represent an opportunity in the hundreds of trillions of dollars. The momentum behind this transformation is only gaining steam as both big and small investors are getting a taste of instant settlement, 24/7 global markets, increased liquidity, and a massive reduction in ongoing compliance costs.
If almost all of VC investment is eventually tokenized as I predict, this widespread adoption of programmable securities will create a new breed of private equity buyers and sellers who will often trade in much smaller investment amounts. There will always be the need for angels and top-tier VCs who stay very close to the streets of Silicon Valley to identify, qualify and provide seed money for newly minted startups. But after a company is up and running, and can demonstrate success, they will have the opportunity to advertise their success on the blockchain, and list on new OTC secondary market exchanges such as OpenFinance, Templum, and the new one being launched by SharesPost.
As companies mature and are in the mood to manage retail investors (and all the additional reporting requirements), they can then list their “STO” on any number of freely trading exchanges to raise additional capital and create more liquidity. Ultimately the most successful companies will move up to the Nasdaq and NYSE digital asset trading platforms currently under construction to gain maximum liquidity.
What’s cool is the greater transparency and broader accessibility of blockchain-based trading networks allows everyone from students to people living in developing nations in on the potential upside. These folks living on the economic edges now have the possibility of making micro-investments in everything from apartment buildings in economically booming centers to the next new technology unicorn. And all along the way, early angel investors and hard-working entrepreneurs can now diversify their risks by taking a little money off the table as they build their empires.
Creating more options for VC LPs
In addition to enjoying accelerated liquidity options, the VC firms themselves will enjoy new benefits by tokenizing their private company investments. For over 20 years my sister-in-law Georganne Perkins used to help manage Stanford University’s endowment investments into VC funds. Given where the money is coming from, Stanford has their pick of which top-tier funds they want to invest in, including the venerable kingpins such as Sequoia Capital and Kleiner Perkins Caufield & Byers. Stanford sees itself, in part, as a long-term investor in the most promising technology companies in the world. With this goal in mind, Stanford’s strategy is to gain early public ownership of tech companies via their venture capital partner's investments, and then take over and manage these investments as public stocks. In the new VC era, the minute a VC find invests in a new company, LPs could then easily take over the management of their share of the security tokens purchased and manage those investments going forward. This practice would require the LP to take on a new level of early-stage investment management responsibility, but may well be an attractive option for the savvier VC fund investors. Dealing in smart securities also simplifies the management of the relationships between and all the reporting and auditing requirements.
Saddle up for a 20-year run
If 2017 and 2018 were the years of the “ICO.” The next 20 years will be the ‘Smart Security’ boom, and Silicon Valley, and the VC industry it invented, will be more accessible, fair, and enjoy tremendous economic rewards investing in the blockchain revolution.
Investor note: As I ponder the eventual and inevitable tokenization of most tradable assets, I am seriously questioning the true value of Bitcoin. When you look in your wallet and see gold and silver-backed tokens, real estate coins, and micro shares in big tech stocks — the value of those investments will be obvious. At some point, we may all start looking at our bitcoin in comparison to these other tokens, and starting thinking, ‘Now what exactly am I buying here?’ And the whole house that Satoshi Nakamoto built will come crashing down. Like we say in Silicon Valley, the early pioneers show us the way but often end up with too many arrows in their back to keep pressing on. These thoughts shall be the fodder for a future post. Your thoughts on this in the meantime would be appreciated.