Waiting for the Angel List liquidity shoe to drop


By Bernard Lunn

Yesterday’s post was about how Angel List ratchets up the disruption of the VC business with the world’s largest seed fund.

Naval Ravikant (Angel List founder) really is changing the early stage investing world with that hippy love & peace logo. Syndicates was the game-changer. The announcement about a $400m Seed Fund to invest in Syndicates is taking Syndicates to the next level.

Syndicates is shoe # 1. This post imagines what will happen when shoe # 2 drops.

Now that software is eating the world, early stage tech investing matters to the rest of us. We might have thought that it was more sensible to invest in safe old hotel stocks – but then along comes AirBnB. Or Banks might have looked safe and then along came Fintech. Very few markets are really safe from the bits of destruction aka digital disruption. So more investors will want to capture the growth of the insurgents rather than being exposed to the decay of the incumbents. More investors want to move to early stage.

Angel List Syndicates is a game changer. It changes how ventures get the funding to go through the first 3 of the 4 pivot gates that Unicorns pass through.

However, early stage investing still has one big problem – liquidity. Entrepreneurs need that in order to get through Gate # 4 for one simple reason – investors and talent need it.

Why investors and talent want liquidity

For the really wealthy, liquidity is not a big problem; it is desirable but not essential. If I have $100m to invest and I put 10% in 10 deals (a pretty sensible diversification) I can afford to wait 10 years to get a return. However even somebody with $100m to invest prefers liquidity, because it gives them optionality. I might like Venture A in which I have $1m locked in but then Venture B comes along and that is far more compelling and I want to sell Venture A and buy Venture B.

For ordinary folk without that kind of money to invest, liquidity is essential. That is why the mass market of investors only normally invests in public stocks, which have liquidity. The new SEC crowdfunding rule changes that. Jane Q Public will be able to invest in startups. One consequence will be the need to offer liquidity. Any marketplace that cracks the liquidity problem will clean up.

Talent also needs liquidity. Stock options are simply a deferred bonus mechanism. Waiting 10 years for a bonus is too long.

Three ways to crack the liquidity nut

I have no idea how Angel List could solve this one. It is a tough nut to crack. Highly regulated public markets can be liquid, but it is hard for smaller companies to operate as public companies. I do know that if there is a way to do this, Angel List will be folks who will do it. They have the network and open networks always win over closed hierarchies in the long term. Their creativity, vision and execution around Syndicates also makes me think they can do it.

There are three ways to solve the early stage liquidity problem:

  1. Funds go public. Plenty of late stage Funds already did this. This is the traditional Wall Street solution. The problem is that you are just layering more fees at the public layer on top of fees at the private layer and networks such as Angel List are all about cutting intermediary fees through transparency and efficiency. Funds going public feels more like the past than the future.
  1. Make private markets semi transparent. This was popular in the months leading up to Facebook’s IPO through markets such as Second Market (now owned by NASDAQ). This is the default option today. These semi transparent markets that allow you to exchange illiquid private stock look very like the early pre Syndicates days of Angel List. They are primarily lists with social validation. They are useful for discovery of ventures to investigate, but the real hard core data is via private negotiation. These are dangerous waters for Jane Q Public. Social validation is a terribly prone to hype and fraud. Any attempts to make those waters safer for the public will make them more like public markets. So it maybe easier to simply fix public markets.
  1. Improve discoverability on public markets using XBRL. I believe this the right way to go. Allow me to bang the drum for XBRL one more time.

The XBRL Revolution is not being televised

This is when people click away. XBRL is geeky and right the bottom of the slough of despond. So bear with me, you know what happens after the slough of despond…

In the wake of the financial crisis in 2008, the US Government mandated machine-readable financial reports via XBRL.

That was a wonderfully progressive move that could dramatically change the efficiency and reliability of the capital markets by bringing financial reporting into the 21st century. (If you are new to XBRL, this post and it’s links will serve as a good starting point).

Lots of people dislike XBRL, because they see it as just another regulatory burden. They misunderstand how financial data items travel through the financial reporting process:

  • Step # 1. Start as an electronic bit in an accounting/ERP system. The data is now perfectly machine-readable and gets aggregated and processed in the most efficient way.

“I will never forget talking to the CFO of one of three largest corporations in world, and he told me that the only time their numbers are on actual paper is when they send their reports to the SEC. That’s because in the corporate world, everything is electronic and digital,”

  • Step # 3. Somebody extracts the data from a PDF or HTML file and turns it back into a machine-readable bit in XBRL format.That “somebody” is probably working for an outsourcing firm that is being paid by the company doing the reporting, because they have to comply with that SEC mandate.

You can see why this song is playing to packed houses:

“Release those poor small companies – the life blood of our economy – from yet another regulatory burden”.

In other words, stop demanding Step # 3. Kill off the XBRL Mandate. Return us all safely to the 20th Century. Forget that the Internet happened.

The solution is not to eliminate Step # 3. The solution is to eliminate Step # 2.

Empower the regulator with data and algos

Imagine the poor overloaded folks at the SEC surrounded by piles of paper. They are dedicated, smart and hard working. They will therefore have evolved a system that sort of works – poring over individual company filings and marking something odd about a data item in a footnote with a yellow pen and then digging though a pile of documents to look on page 256 of another report (having cleverly marked the page) to correlate something odd on that other company’s filing…

Imagine if all the data was in XBRL electronic format and they could let an algorithm do the grunt work, so that they could do the higher-level pattern matching work needed to catch the bad guys and maybe avoid a repeat of the financial system’s “cardiac arrest moment” in September 2008.

The algos could process thousands of companies to look for that anomaly, that weird thing that says, “something looks fishy”. The data surfaced by the algos still requires the higher-level cognitive and pattern matching skills of humans. This is about empowering the SEC staffers to be more efficient. I imagine that they would vote for this change.

The work done by SEC staffers is impossible without better systems. The devil is in the details, or to put that in financial reporting language:

“The devil is in the footnotes”

The footnotes are where a company buries that embarrassing fact that they want investors and regulators to gloss over. Scam artists use that footnote technique; that is an edge case. More normally it is used by companies to simply “accentuate the positive” while abiding by the letter of the reporting law – obfuscation through obscurity.

We want the SEC to be efficient and to catch the bad guys. Imagine a tech-empowered SEC staffer being able to check a data point across thousands of reporting firms through a single algorithm that can be continuously improved.

Let Short Sellers find the needle first

Finding fraud in the system is hard work; it is like finding a needle in a haystack. The vast majority of companies are honest. The fraudsters are smart and work hard to cover their tracks. Armed with great data and algos, SEC staffers might have a fighting chance.

However if the XBRL data was streaming out publicly they would get a lot of help from the private sector. This does not require any crowdsourcing through altruism. The same process of poring over footnotes and finding “fishy stuff” is what short sellers do. So they are highly motivated to find the bad guys early. They would be the first to find the needle in the haystack. Or, mixing my metaphors, the short sellers would put the fraudsters neck on the chopping block and the SEC would deliver the coup de grace.

Straight Through Processing is not that tough

Saving XBRL is not just about the efficiency of the SEC and catching bad guys. The bigger issue is about making the capital markets an efficient place for small companies to raise money and for retail investors to make money. This is where the story about saving small companies from the regulatory burden is so misleading.

If you eliminated Step # 2, there is no burden, even for small companies. It is straight through processing. Eliminating Step # 2 might entail a tweak to the SEC Mandate to mandate not just human-readable conversion of XBRL to HTML but the transmission of the raw XBRL data feed. Once that mandate was in place, CFOs would call their Accounting/ERP software reps and demand XBRL built into their core systems.

That change might take longer for BigCo – the existing public companies – because making enterprises change when they have lots of legacy systems is really tough. However it is not so hard for the kind of young digital native ventures that raise money on Angel List. It is quite normal for them to be Straight Through Processing all the way from transactional networks to financial reporting. For them going to XBRL reporting really is a tweak.

Discoverability to escape small cap hell is the real value of XBRL

So much for the burden of XBRL. Why do small public companies need XBRL?

Small public companies need XBRL for discoverability.

It is the same reason that anybody running an online site/blog wants to be discovered by Google. You want your site to be discovered.

The CEO/CFO of a small publicly listed company wants to be discovered by investors. Obscurity is their biggest enemy.

These emerging growth companies (less than $250m in annual revenues) are too small to motivate analysts to pore over their individual filings. However if all their data is machine-readable, their company can be discovered by algos looking for bargains.

Angel List could drive this change. Their Syndicates fixed the back office issue – at the deal initiation stage. This is a game changer. Syndicates is shoe # 1. The market is waiting for shoe # 2 when they fix the back office issue – at the financial reporting stage. XBRL is the enabler for that. Imagine if Angel List allowed investors to track and evaluate all the companies in their portfolio at the financial reporting layer. This would be private and transparent. It would be a simple step from there to public and transparent.

Daily Fintech Advisers provide strategic consulting to organizations with business and investment interests in Fintech.







  1. This is a brilliant piece in terms of systems thinking. I have been reading your blog for over a year and love every page of it. I am a crypto-money and start-up enthusiast with a strong research background. This article is what aims at the game changing bits of the coming era. This changes not only the definition of credit money (IOU) as used under the garb of fiat money; it changes much more.

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