T-Zero sings “Love me do” to the SEC with its Blockchain Series A Preferred Shares

t0

Wonders are still happening in America!

Who would imagine that an online retailer who started out as an e-commerce business liquidating merchandise of failed companies, would be the first publicly traded company offering Blockchain Shares.

Let me introduce to you Overstock, a Nasdaq listed online retailer (OSTK) based in Utah and founded by Patrick Byrne.

Tee-zero (t0.com) is a majority owned subsidiary of Overstock that is focused on using blockchain technology in capital markets. Last summer, we covered the issuance of a private crypto-currency denominated bond that settled on the T0 platform. It was a symbolic move, demonstrating that it is possible to issue, trade & settle (synonymous in the future T0 world), and have very fine divisibility of a bond and fast transferability. The trading activity of this bond was not the point of the implementation.

This December an even more important symbolic implementation happened. After the SEC approved in early Fall the issuance of a blockchain public stock offering; Overtstock will go down in history as the first publicly traded company that offered blockchain shares trading on an Alternative trading system (ATS).

The historic offering: Overstock Preferred Shares

Voting Series B Preferred Shares

  • 560,333 @ $15.68 (roughly $9mil)
  • Trading on NasdaQ OTCQB

Blockchain Voting Series A Preferred Shares

  • 126,565 @ $15.68 (roughly $2mil)
  • Trading on ATS under the symbol OSTKP

The above offering (total roughly $11mil) was handled by Keystone Capital, a conventional broker-dealer that worked diligently and closely with the regulators to obtain the required approvals.

Existing shareholders had the right to participate in the offering as follows: One subscription right for each 10 shares of common stock owned. Each share of the preferred stock has a preferential right to a 1 percent cumulative annual cash dividend.

The symbolic significance of the Blockchain Series A transaction is all about the

Transparency of the transaction and the fact that it boils down to the verification of two blockchain addresses.

What’s next?

I wasn’t an Overtsock shareholder on the required date and therefore didn’t participate in the offering. The broker-dealer, Keystone Capital handled the onboarding of the buyers (existing shareholders that exercised their right to buy the Series A preferred stock) of the digital securities. They created digital wallets and accounts for them and are now continuing to onboard outside buyers who will be matched on the T0 platform to sellers (those that participated in the first placement). Any individual that qualifies under the Title III Jobs Act, can participate.

Nasdaq is watching and probably nodding its head, since a large-scale adaption of such a process is not imminent. However, it is threatening to its core business.

Stock exchanges are one of the main three categories of players involved in capital markets; Brokers and Central Securities Depositaries handling settlements, are the other two main categories. The million-dollar question here, is who of them will embrace the T-zero or some such blockchain based platform and make the other two obsolete?

T-Zero is actually a viable product that targets the capital markets B2B vertical and is out there for the first mover to embrace it. Ironically T-zero is a private blockchain. In addition, this first symbolic implementation was accomplished with the participation and collaboration of market players and intermediaries that will be directly affected should this technology prove to change the capital markets infrastructure. Broker-dealers for example, which were instrumental in obtaining approval from the SEC and effectively laying the seeds for the growth of such an ecosystem of digital assets; will be cannibalized.

At the same time,

T-zero with Keystone Capital, are bringing up to speed the SEC and holding their hand towards Full Regulatory Transparency in public markets.

For me, this symbolic transaction is the first public performance of “Love me do” from T-zero to the SEC. Right at the time that the SEC has committed to a plan to spend $1.5billion to create a consolidated audit trial (CAT), T-zero is echoing loud and clear to them “Love me do”

T-zero can offer a freemium service to the SEC, if they adopt the T-zero platform which will naturally include a Consolidated Audit Trial.

If T-zero manages to seed an ecosystem of publicly traded digital assets (even if it starts small); then I foresee Lykke, the frictionless global marketplace for digital assets, accelerating its growth. Lykke, an open source platform, has started with frictionless, transparent, immediate settlement of FX, ICOs and cryptocurrencies, but is ready to broaden its assets base (anything digital can be on boarded).

The transformation in capital markets is here. Timing is uncertain but the trend is clear.

Sources: T zero news; Nasdaq news

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network. Efi Pylarinou is a Digital Wealth Management thought leader.

Golem and the ICO ecosystem

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The Golem anthropomorphic figure

The Golem deal beckons us to revisit the ICO market. Our recent coverage can be found in IPO or ICO or IEO (briefing on Colored Coins) and Transparency missing from the suppliers of Capital to Fintechs.

Golem’s ICO is over. It raised 820,000 ETH (roughly $8.6 million) in a couple hours.

As reported by Smith + Crown

Golem is backed by the Ethereum blockchain and is a platform that aims to become a decentralized hub to create global marketplace for computation.

The Golem Network Token (GNT) was created through this ICO and is the medium of exchange between “buyers” and “sellers” on the Golem hub. So, those engaging on the platform (developers creating software, providers supplying infrastructure and “requesters” ordering computing resources) will trade GNTs.

Golem is the third largest ICO deal. In the ICO market, any deal above $1mil is considered large. Not many people are aware that the ICO market has facilitated around $220mil in capital raised over the past three years. The really large deals are, Ethereum who raised $18.5mil during its ICO and the DAO with a wopping $180mil (a tragic example).

Access to capital has and will be a business essential. The IPO market was traditionally gated by the investment banks and is being disrupted by Fintechs like Angel List, Syndicate Room, OurCrowd etc.

Crowdfunding, transparency in the syndication process, cross border deal facilitation, are ingredients of the underway disruption that are leading to access to capital without being listed on an exchange (i.e. public markets) and to improved liquidity in these private shares.

So where does the ICO (Initial Coin Offering) disruption fit in to this? The basic facts and distinctions are:

  • ICOs are one way of crowdfunding.
  • ICOs offer a cheap, transparent share ownership process.
  • ICOs can be thought of as a derivative of a bitcoin or other digital currencies, because in the process the company issuing shares is creating an Altcoin typically with its name but not necessarily that is a colored, smaller part of the bitcoin (which has 100,000,000 satoshis and therefore, could be divided in that many pieces). The small denomination will also help liquidity.
  • ICOs are a way to access global capital simultaneously; whereas traditional capital raising starts in one regulatory jurisdiction and thereafter, may choose to also list in another exchange. ICOs seem more like the FX market that trades internationally, rather than the equity markets.
  • ICOs can and are launched from very early stages of business development. They are a cheap, effective way to participate in early stage ventures.
  • ICOs can and will benefit from the liquidity traction of the underlying digital currency from which it is created.

Open issues relate to whether (actually not discussed that much):

  • ICOs are legitimate and how they could be regulated?
  • Are they an investment or a speculative trading asset?
  • Will they remain confined to facilitating funding of techie types of companies?

The ICO ecosystem

The Fintech ecosystem is building up to track, analyze and service the ICO market.

Smith + Crown, is the place for news, research, and analysis of cryptocurrencies, blockchains, cryptofinance, distributed autonomous corporations..

It offers a dedicated page to monitor past ICO deals and those upcoming.

ICOstart is a new marketplace (i.e. exchange in old parlance) to issue and trade the Altcoins from these ICOs.

ICOO is another new place to go, to track pre-launch crowdfunding ICO deals and to be able to trade them immediately thereafter, on the Open Ledger platform. This is a company created by CCEDK in collaboration with Openledger. CCEDK is the Danish bitcoin exchange that closed in May and relaunched in July, more as a hub for crowdfunding, issuance of assets, escrow accounts.

Daily Fintech will continue monitoring the space and reporting.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge Network.  Efi Pylarinou is a Digital Wealth Management thought leader.

Briefing on Colored Coins – IPO, ICO, IEO

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The new kid on the block is IEO (Initial Equity Offering). I coined that phrase because neither IPO or ICO fits.

– IPO (Initial Public Offering) implies listing shares on a regulated Stock Market such as NYSE, Nasdaq, LSE, SIX etc. 

– ICO (Initial Currency Offering) implies issuing a new Alt Coin. The problem is that Alt Coin are not getting any serious market capitalization. For students of exotica, here is the market cap of the top Alt Coins. The last thing the world needs right now is another AltCoin.

If it is broke, do fix it

A regulated Stock Market is how the market works today. The old saw is if it ain’t broke, don’t fix it. The corollary is if it is broke, do fix it.  Here are the 4 big flaws with these legacy Stock Markets: 

  • legacy listing processes: post Enron, the SEC (followed by other Exchanges) layered on lots of expensive process to protect investors from scams, all of which were based on manual processes (which later got automated but they were still not native digital ie they were expensive and inefficient).
  • national boundaries: it is too hard to discover stocks on exchanges in local markets, so they either suffer a valuation discount or seek a listing on one of the global exchanges (where only mega-sized companies can do an IPO). (See here for our other coverage of this issue).  
  • declining revenue line from listing fees: Stock Exchanges increasingly make their money from selling data, co-located servers for HFT and payment for order flow. This leads to misalignment of interest with the two customers who matter – issuers and long term investors.    

This post, earlier this week by Efi, describes how things went wrong at traditional regulated stock exchanges.

Why Microsoft did an IPO

They did not need to raise money – they were already profitable. They wanted liquidity and price discovery so that they could motivate employees with stock. That is the function of a public market. Any public market 2.0 initiative has to bear that in mind. Investors want to buy shares of profitable business. Uber’s $66 billion valuation in private markets is being questioned because investors cannot figure out how they still lose money after having got to such scale. Then consider a bootstrapped business such as Microsoft at their IPO 25 years ago or a Mittlestand company in Germany. As an investor, which do you prefer to own? That is what the Innovation Capital business should be serving and is not.

Colored Coins 101 for business people

Part of our mission at Daily Fintech is to demystify jargon that obfuscates. We translate Fin for Tech and Tech for Fin. In this case we are translating Tech for Fin. There is so much innovation around Blockchain that it is hard for business executives to keep up to date. Our job is to find the stuff that matters and bring it to your attention.

We think Colored Coins is an important development in the Blockchain world. We will parse the tag line on their front page to explain why: 

The Open Source Protocol for Creating Digital Assets On The Bitcoin Blockchain

  • Open Source Protocol. This is like TCP/IP or HTML. No company controls it or makes money directly from Colored Coins. You make money by adding value on top.
  • Creating Digital Assets. You don’t buy an Alt Coin. Let me repeat that. You don’t buy an Alt Coin. You “color” an existing Bitcoin ( % of a Bitcoin or number of Satoshi, which is the smallest divisible unit of a Bitcoin) to represent an asset (stock in a company, a house or car or painting or whatever). Then you can buy and sell those assets frictionlessly across borders. 
  • Bitcoin Blockchain. This is about the public Blockchain. You can also use Colored Coins on Ethereum (another popular public Blockchain). If you believe that all Blockchains will be private, this is not for you. Using the analogy with the development of the Internet, this is about the Internet not a collection of Intranets. Open Coin transactions are validated by a consensus network (either Proof Of Work by Bitcoin Miners or Proof Of Stake or whatever Ethereum uses). 

Of course, an open source protocol is only as good as the use cases created by entrepreneurs. That is the subject of a future research note.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

Whatever happened to…11 startups graduating from Barclays Techstars 2 years ago

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2 years ago I attended the Barclays Techstars graduation day pitch in London. My report from then is here. I was excited and impressed, but knew the stats about startup survival rates. So I thought it would be interesting to do a Whatever happened to… followup post two years later (an eon in startup time).

I put them into 3 categories based on recency of funding as per Crunchbase (if they have it wrong for your company, please update Crunchbase and tell us in comments). Funding is a proxy for traction but only a proxy. If the company is thriving the old fashioned way by customer revenue, please tell us in comments.

Category 1. Never raised money beyond Seed in summer 2014.

They may still be in business. (If you are, please tell us in comments and update Crunchbase). Most probably they are not still in business and the best one can say is that they failed fast, losing little of their own time or their investor’s money.

ClauseMatch

Crowd estates

Gust Pay 

Try

Vieweet

Category 2. Has not raised money in last 18 months but did raise some money after the summer of 2014.

This is worse (unless Crunchbase is wrong and they are thriving) as it took longer and cost more to get to the same place as Category 1.

Glimr.io

Squirrel

Category 3. Has raised money in last 18 months.

These are the ones that may make it through that uber Darwinian process known as creating a high tech startup. Their journey will be a tale worth telling. Even these are on the early stage of this journey – they may have reached Basecamp on their way to Everest Summit. This is hard and takes time.

DoPay

Aire

Novicap

Hard to Categorise

TheMarketIQ

There is no sign of funding on Crunchbase but other signs of health indicate they may still be around but just keeping funding sources quiet.

It’s a Darwinian Process

So, How was my original analysis?

My three top rated ventures were Aire, Squirrel and Do-Pay. It looks like I may have got one out of three right – Aire is clearly raising money and getting traction.

At the event, Barclays Techstars was talking about their filtering process to get from 340 applicants to 11 that got into the program.

To get a real result for investors and founders means a liquidity event – trade sale or IPO. So even the 3 in Category 3 are only at the start of their journey.

It’s a tough Darwinian process for founders and entrepreneurs, with plenty of excitement along the way. Failing fast and trying again is the mantra for founders; investors have a portfolio so many failed ventures are OK if they get one big winner.  So tales of ventures not making it should not and will not deter those who want to give it a go.

We may see these ideas resurface

Research shows that the single biggest factor in startup success/failure is timing.Many of these maybe great ideas, but the timing was off. We may see these ideas resurface with a different name/team.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

Fintech Unicorn pain as the public/private valuation inversion comes to an end

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# 6 on our Fintech Predictions for 2016:

 The strange inversion we saw in 2015, when private companies were valued higher (on paper at least) than public companies, will end in 2016. The headlines will refer to Unicorpses.

 This is happening now. It is happening in private unless a business totally blows up like Powa and Mozido. So we don’t normally read about what is happening behind closed doors. This post aims to shine a light on what is happening, but only using data that is in the public domain; if we had any inside knowledge we would be under NDA. However there is so much data in the public domain that one can gain insight if one knows where to look and what questions to ask.

 We don’t do negative reviews on Daily Fintech. We are entrepreneurs ourselves and we respect the tough journey that other entrepreneurs are on. If we don’t rate the chances of what a venture is doing, we simply don’t write about that venture. However we also like being realistic and avoiding hype. So occasionally we like to shine a light on issues that the whole Fintech community faces.

The Fintech Unicorn List

This a list of Fintech Unicorn ventures from Business Insider dated August 2016 ranked by valuation:

Rong360

China Rapid Finance

Coupa Software

Jimubox

Kabbage

Funding Circle

Gusto

TransferWise

FinancialForce.com

Prosper

Avant Credit

One97

Zenefits

ZhongAn Insurance

GreenSky

Klarna

Adyen

Mozido

Oscar Health

Credit Karma

SoFi

Stripe

Qufenqi

JD Finance

Lufax

Ant Financial

Analysis using Recency & Down Amount

Private rounds are negotiated in…private. We have no inside knowledge of these negotiations and if we did have inside knowledge we would be under NDA. Two things indicate that a venture might be having trouble raising money:

Recency. If a high profile venture has neither raised money for 18 months, nor released financials to show that they are profitable, it is possible that fund raising is a challenge. The normal rule is to aim to close the next round within 12 months (and in good times you see that schedule) but have enough cash to move that to 18 months. Many entrepreneurs do get out of this hole and many investors will back them during this time; but it can be a warning sign. We see three ventures in this category:

  • Green Sky (the investor is a PE Fund and they typically like profitable companies and so Green Sky maybe growing through internal accruals).
  • One 97 (but note that their last round was $500m and that goes a long way in India).
  • Mozido. This company is clearly having deep problems.

Down Amount. The normal trajectory of a high growth company is to raise more with each round. When one sees a lower amount than the previous round it can be a warning sign. We see two ventures in this category:

  • Klarna
  • Transferwise

We used Crunchbase  for this analysis because it is open and free – so anybody can check the data (and change it if it is wrong). Our philosophy at Daily Fintech is to do original research on public domain data – no insider knowledge and no proprietary data sources.

The New Unicorn Status Club

Being valued at $1bn is soooo 2015. The new status badge is a single investment round over $1bn. In that elite club in Fintech we see:

SOFI

LUFAX

Ant Financial (with a staggering $4.5bn Series B in April 2016).

One 97 in India comes close with a $500m round, which is huge for a country where venture capital has not historically flowed easily.

We are only tracking private companies. Public stocks are a different story; that data is visible to all. The problem for the private companies is simple – the valuation comparables are in the public market. For example, if you are a Market Place Lender, valuation comparables will include Lending Club (LC), Ondeck (ONDK) and Yirendai (YRD). If you are a Payments venture, PayPal (PYPL) and Square (SQ) will be among the comparables. You can short a public stock, which acts as a good price discovery discipline. That shorting price discovery discipline is not available in the public markets, which is why we got that strange inversion in 2015 that is unravelling in 2016.

The Asia story

Looking at the location of these Fintech Unicorns we see:

  • Europe = 4
  • Asia = 9
  • America = 13

If you look at amounts invested, Asia is far bigger and the source of capital is different (more Corporate than VC fund with LP/GP structure). But that as they say is another story.

Mozido

It’s tough being in the news business. Business Insider published this list in August with Mozido as a Unicorn and in September, the news sites are writing the post mortem analysis (such as this one in Forbes). It is worth noting that two other big Fintech Unocorn flameouts – Powa and Monitize share a business model – white label payments. We have long held the view that payments is the “boulevard of broken dreams”. The Mozido story seems to confirm that.

The Mozido story also illustrates why the funding recency analysis makes sense. The last round listed on Crunchbase is October 2014, well over the 18 month bar we set.

It takes 9 months to make a baby

And it takes 10 years to make a real Unicorn. By a real Unicorn I mean with $1bn in cash from a trade sale or $1bn in the public markets after shorts have tried to bring it down.

Yes, it has occasionally been done in less than 10 years, but that is rare. VC funds need entrepreneurs to do it in less than 10 years as they need to return cash to LPs. If you start on that high trajectory path, it is hard to avoid a huge flameout if things don’t go according to plan. Two Plan B options are fraught with danger:

  • Pull back on the growth throttle and get to profitability. Your investors did not back you to do this and the deal terms may enable them to force an exit.
  • Trade Sale. Strategic buyers are making the public market comparables analysis and will apply those to the valuation.

Software is eating the world and 50% of the 7 billion people on the planet are using a mobile phone. So, super high growth is possible. Yet the ending of the public/private valuation inversion could never end without some pain.  This is a high stakes game.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

Elio shows that Crowdfunding wins when it focusses on real world innovation

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Elio Motors is the poster boy for Reg A+ Crowdfunding in America and Reg A+ could fundamentally change how capital formation takes place.

The Elio story shines a light on crowdfunding, but it also shows that Crowdfunding wins when it focusses on real world innovation. Traditional FinServ does a good enough job financing the old. Fintech scores best when it finances the new.

Old fashioned story?

At first sight, Elio Motors looks incredibly old-fashioned – a car built in America and it is not even electric and unlike a Tesla you won’t find pictures of celebrities driving them. This is a car for poor people in America that will cost $6,800 and deliver 84MPG.

It is close in spirit to the Tata Nano in India, the first car for a family that is upgrading from a motorbike that costs about $1,500 new. Who knew there was a market for a car like this in America? Yes, there are poor people in America who need a cheap car. For a funny/sad take on this watch John Oliver’s takedown of subprime auto lending

Personal story: a few years ago I gave a hitchhiker a lift in America. Having been a hitchhiker in my youth it felt like the right thing to do. But this was no young student having fun. It was a middle aged woman trying to get to work after her car had been repossessed.

A cheap car is very much needed in America.

Elio reality checks

  • #1: it is more like a trike than a car (but if you need something to drive to work in the rain who cares about the label?) If you can afford a more expensive car, you may not be in the market for an Elio.
  • #2: it is still a prototype. The 50,000 people who placed pre-orders will have to wait until 2017.  But read that again – 50,000 pre-orders – yes there is a market for this.

The crowdfunding story

Hey, this is a Fintech site, not an Auto site, get to the point. The Elio story is about how innovation is funded and how capital is formed and how retail investors can make money in the stock market. In short, even if you are rich enough to afford an ordinary car, this is a big deal.

The Elio Motors Reg+ CrowdFund campaign was managed by a Los Angeles company called CrowdFundX. In this 30 minute video, their CEO Darren Marble explains how they did it. In short, it is like any online marketing campaign.

What is extraordinary about Reg+ is that you can market the stock of your company like any online marketing campaign. Actually what is extraordinary is that prior to Reg+, you could not market the stock of your company like any online marketing campaign. You had to go through a high touch (read, expensive) campaign of selling to accredited investors. There will come a time when that will seem as out of date as a fax or telex machine.

For more on the stock market side of things, the Press Conference for Elio Motors stock market launch at OTC Markets has it all (but beware this is an hour long)

92% and 14.8%

RegA+ allows entrepreneurs to market their stock to non accredited investors. That is 92% of the American population.

To put that another way, before RegA+ you could only market to 8% of the population. 92% and 8% does not have the sound bite of 99% and 1% but may reflect reality better.

Elio Motors may sell stock to the 92%, but they will mainly sell their car to the 14.8%. This is the 14.8% living in poverty in America.

Of course, you don’t have to be officially poor to buy an Elio. You could be a Millennial loaded up with student debt in a weak job market just wanting to be frugal enough to get out of Mom & Dad’s house.

Who knows, it might even get chic status in LA. So we might see celebrities pulling up the red carpet in an Elio?

Needed – financing for a new cheap car

The poverty trap means that even $6,800 looks like the price of a private jet to somebody living in poverty. Paying $6,800 for a new Elio is better than paying double Blue Book value plus high interest rates (watch the John Oliver takedown on subprime auto lending).

So, some Fintech entrepreneur needs to come up with loan financing for a $6,800 new Elio. Let’s run some numbers. Assume 4 year amortization, payments will be $142 per month. Add 10% interest (not so bad in a ZIRP/NIRP environment) on the declining balance and the borrower ends up paying $16,622 in interest over 4 years. 4 years to own a car outright is a dream for many people. Poor people may need some philanthropic or government assistance to make the numbers work, but it must better than the world of subprime auto lending.

Audited Financials and Reg A+

A few months ago I wrote a skeptical post about crowdfunding. My concern is that soliciting money for stock without audited financials is breeding ground for scams. It turns out there is devil in the details in this regard for Reg A+. As per the SEC site, there is Tier 1 and Tier 2:

  • Tier 1, which would consist of securities offerings of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer.
  • Tier 2, which would consist of securities offerings of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.

Tier 2 have to file audited financial statements on an annual or semiannual basis as well as “current event reports”. Tier 1 companies may choose to do this, but don’t have to. As an investor my rule is simple – I won’t invest unless I get audited financial statements. Reg A+ companies are public. They are just smaller public companies.

Better than buying hot stocks at IPO or in private markets?

Buying a RegA+ public company has risk (even with audited financials). Everything has risk. But compare that to buying a hot stock at a high valuation at IPO for a mega venture like Uber (so that the people who bought earlier can sell) or buying that hot stock at a high valuation in private markets where you might not get all the disclosure and financials that you get in public markets.

Fintech is great, but math is merciless

Old FinServ finances old stuff well enough. Fintech scores when it finances innovation. When we look at big markets such as Health Insurance and Education Loans, we can see the limits of Fintech. You cannot change the underlying math with a new UX or even a marketplace model. To change HealthInsurance or Education Loans you need to fundamentally change how they are delivered and priced.

The same is true of Auto Loans. When the average price of a new car is over $33k, a few % points less on interest, while useful, does not fundamentally change the game.

Supplier networks and the return of local manufacturing

When Elio Motors launched the P5 at the LA Motor Show, what really comes across is that this is a car built by a network of suppliers. This is not a vertically integrated GM from the 1950s. This is closer the network of companies that build motorbikes or electronics equipment in China (described in this 2005 article in McKinsey Quarterly).

The other Chasm

There is a well-known chasm between Minimum Viable Product and Product Market Fit.

The other chasm is less well known. This the chasm between high quality company and IPO. Uber has a valuation in private markets of $66 billion and yet “it is too early to go public”. Huh?

An IPO is a branding event as much as a financing event. If you have a product that people want they will pre order it. Kickstarter has proved that. Then you can go to Equity Crowdfunding platorms. Then you fall into Chasm between viable company and being big enough  to get to the massive valuation that Wall Street bulge brack investment bankers require before they will take you to IPO. RegA+ can change that game, so that fewer entrepreneurs  fall into that chasm.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.

The VC business is finally being disrupted

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VCs love to invest in technology and business models that disrupt the old established way of doing things. The irony that VC is now an old established way of doing things has not been lost on many people and the disruption of VC has been much forecast for many years (and as cynics will point out, this has not yet happened). This post explores the thesis that this is finally about to happen thanks to the confluence of investor demand, technology and tax change.

 ”Your fat margin is my opportunity” (Jeff Bezos). 2% AUM fee on a $1bn fund is $20m a year. That is not a lean, mean operation – that is a fat margin. That is before delivering any result to Limited Partners (LPs). That is $20m out of investors pockets before they see a dime from the profit share. That is incentive to raise a big fund and research shows that big fund size is a contrary indicator to fund performance. Who cares about profit share when you can earn $20m a year without earning any profit for your investors? Of course that cannot last and that is why change is coming to the VC business, enabled by the technology innovations that VCs funded in the past.

Investing in startup funds is as risky as investing in any other startup

Two data points from that Ivey report will make investors pick up that Vanguard brochure selling low cost Index Funds:

•For two-thirds of the VC firms, the first fund is their last fund.

•Only 10% of the VC Firms Launch More Than Four Funds.

You cannot invest in those 10% of top tier Funds, unless you happen to be lucky/smart enough to invest in their first fund and have the right to invest in future funds. Yes, it is like the old Groucho Marx joke: “I don’t want to belong to any club that will accept people like me as a member”.

VC Has become part of the asset management business

It did not use to be like this. Finding a young and unproven team and backing them all the way with everything (money and contacts and advice) is still done by a few real Innovation Capitalists but a lot of what we call VC has become Momentum Capital, chasing hot deals.

The preferences that some VC load onto deals make it almost a debt instrument and create fundamental misalignment with entrepreneurs.

Late stage deals are like investing in public companies.

The 2 and 20 model is at risk across the whole private equity business. VC may simply be the canary in the coal mine.

From gather then invest to invest then gather

If you wanted to be a VC GP (General Partner), you first approached investors (Limited Partners  or “LPs”) and persuaded them to invest for about 10 years while you as the GP invested in and exited from the next Facebook. This model is flawed for both LPs and GPs:

  • LPs have to invest in a startup fund and like most startups, it is possible that the startup fund will become the next Sequoia Capital, but read that Ivey Report to see why this is statistically unlikely.
  • GPs have to spend a lot of time gathering assets (which gets harder as the data points described here get commonly accepted) when they could be investing in startups or doing something else more lucrative.

From 2 and 20 to 0 and 40.

Investors are quite happy paying 20% as a profit share compensation (called “carry” in VC land). Heck, they will pay 30% or even 40% (particularly if it is 40% over some nominal risk free hurdle such as US Treasuries) if the GP will drop that 2% AUM fee.

The job of finding and nurturing tiny, young companies that turn into great big mature companies is hard. The people who know how to do it should be well rewarded. Most business are usually happy to share a big % of the profits on something if the other party takes a big risk as well. Paying 2% of AUM is zero risk to the GP and total risk to the LP. If you took away that zero risk 2%, most investors would be willing to increase the carry/profit share % from 20% to 30% or 40%.

If we stayed in the mode of gather assets then invest, the 2% fee will stay – it is the only game in town and it is a game that rewards skills in asset gathering more than skills in investing. However, the new crowdfunding services using syndicates such as Angel List and Syndicate Room change this dynamic to invest then gather assets. This post on Angel List describes how this works.

This matters more now than ever now that software is eating the world

Many investors have studied that Ivey Report and simply decided to stay away from VC as an asset class. Instead they focus on companies that have already reached maturity. The problem is that if software really is eating the world, this “safe strategy” is increasingly risky because it is more of a zero sum game than the venture business likes to talk about. If AirBnB scales, it does so at the expense of the traditional Hotel business. If Fintech ventures scale, they does so at the expense of the traditional Financial Services business. If Cleantech ventures scale, they does so at the expense of the traditional carbon fuel business – and so on. Investors looking to the long term – such as Family Offices and Foundations – need to invest on the right side of this disruption.

Many VC will follow Hedge Funds to become Family Offices 

Masters of the Universe don’t die, they just fade from the headlines. VCs that already made $ billions don’t need AUM fees. They can simply invest their own money, without the hassle of managing somebody else’s money. Many Hedge Funds have already done this. The tax law in America that taxes carry as if it is risk capital (i.e at the lower capital gains tax rate) not fee income has a high likelihood of changing no matter who becomes President. These VC turned Family Office can then invest in Syndicates who invest first and then gather assets. This is where the confluence of technology, business drivers and tax law change creates the tipping point.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech & operates the Fintech Genome P2P Knowledge platform.