Calpers and the quiet data driven disruption of Private Equity


Private Equity is a classic clubby insider high margin business. If open data and networks always disrupt these types of business, then Private Equity is overdue for disruption. 

This post offers:

  • A brief history of Private Equity.
  • Private Equity in context to other asset classes.
  • Two big problems facing Private Equity.
  • The disruptive power of open performance data and what Calpers is already doing to bring about this change
  • One disruption scenario.
  • One venture going after this space.

This post is specifically about investing in mature, profitable private businesses. This is in contrast to early stage investing which is already being disrupted by crowdfunding networks for both accredited and non-accredited investors. Private Equity deals are usually control deals (vs early stage that are normally minority equity), so we usually refer to this as Private Equity Buyout. 

A brief history of Private Equity Buyout

Private Equity Buyouts has gone through three iterations:

  • Version 1: Lean Conglomerate. This was pioneered by Hanson Trust in the 1970s. They bought underperforming old companies and put in financial discipline and a new CEO who got a piece of the action after the business was sold. Hanson Trust was an operating company with diverse businesses, so the right name is conglomerate, but they kept Head Office very small and they were always willing to sell a business if the price was right. Their mental set was closer to a Fund than an operating company, so the appropriate tag is Lean Conglomerate. Many other firms did well applying the Hanson Trust model in different markets (often learned while working at Hanson Trust). For example, Misys took the Hanson Trust model and applied it to software and now there are many such software conglomerates.
  • Version 2: Leveraged Buyout Funds. This cut the HO function down even further so that Conglomerate morphs into Fund, but the practices and techniques were similar. KKR was the pioneer in the 1980s. These Funds use leverage to juice returns and force cost cuts. Using strong cash flows to pay down debt, a Fund could sell after 5 years without even changing the business and still get a good return.
  • Version 3. Take Private. This requires more work than the Leveraged Buyout model. It is about fixing what is dysfunctional in public markets – an obsession with quarterly earnings. Transformational change requires more than one or two quarters. One example is the $11.3 billion 2005 Sungard deal. Sungard, like Misys, had grown through acquisitions and at a certain point the result was too messy and the business needed to be revamped out of the eye of public investors.

Private Equity in context to other asset classes.

Private Equity is small in total assets compared to asset classes such as Public Equities and Fixed Income. Private Equity is one part of Alternatives which was $7.2 trillion in 2013 vs $56.7 for Traditional Investments. But note the growth rates.


However, Private Equity is big in one area which is Fees. In this FT article it is revealed that one pension fund alone (Calpers, more on them later) paid $2.4 billion in fees to PE Funds.

High growth and high margins means that any entrepreneur listening to Jeff Bezos (“your fat margin is my opportunity”) should be paying attention.

Problem 1: Software is eating the world.

Private Equity Funds pitch themselves to Investors as being more conservative/less risky than their wild cousins doing early stage equity. They will do rigorous analysis of the past 10 years or longer to see how predictable the cash flows are. No dangerous projections based on new products for them, their models are rooted in real world actual results of proven products.

That sounds good, but is based on a fundamental error which is the assumption that the future will be like the past. The Digital Era overturns that assumption.

Consider the printed telephone books aka “Yellow Pages”. They were a license to print money for a long time and many Private Equity Funds bought into them for that reason. Now it is hard to find people who use printed telephone books for anything other than doorstops.

Or consider hotel chains after AirBnB or Private Banks after Robo Advisers. How do you model future cash flows in those scenarios?

Problem 2: capital oversupply

When everything else changes, you can count on the law of supply and demand as a constant. Private Equity has been such a good business for so long that investors have been pouring money into the best funds (who then get high fees on AUM and the ability to do the mega deals). The problem is that this results in a lot of capital chasing the best deals (what Private Equity guys call “dry powder”) which raises prices on entry and that depresses returns on exit.

Calpers – its the data stupid

Into this closed, clubby world (”if you have to ask the price you cannot afford it”) comes Calpers (California Public Employees Retirement System) with their Private Equity Program Fund Performance Review. This is data transparency in action. It is only one investor but that investor is so big that it is a significant data point. You can sort all the PE funds online by all these different criteria.


Our thesis is that this data will drive a lot of innovation. Entrepreneurs will be able to show what they offer vs the competiton by referring to this data. It is like an Index for the Private Equity business.

Disruption scenario

Our thesis is that disruption will come from Family Offices, managing money for the Ultra High Net Worth Individuals (UHNWI) and their families. In the US alone there are 3,000 single-family offices with assets under management between $1 trillion and $1.2 trillion.

Four key points about Family Offices:

  • They like the high returns of Private Equity and don’t worry about the lack of liquidity with money “locked up” for years (because they are managing money for multiple generations).
  • They are agile because they don’t have any “explanation risk” (if something goes wrong they can learn from it and move on, they don’t have to explain their actions to investors).
  • They don’t compete with each other.
  • Many are still run by entrepreneurial families (who are used to taking measured risks to get better returns).

This makes the Angel List model of following a proven investor applicable to Private Equity. This is already happening in a small way with small networks of like-minded Family Offices working together on deals (referred to as “club deals”). This is where the entrepreneurial genes of the Family Office counts. Let’s say Family Office A made their money in Pharma and Family Office B made their money in Software. Family Office A follows Family Office B’s lead in Software and vice versa.

Angel List obviously works at the early stage end, but the brilliance of their innovation is that they take of all the “boring plumbing admin” stuff like reporting. That can apply to any form of asset management, including Private Equity.


One company going after the Private Equity space is Axial. They recently raised a $14m Series C and are led by a proven entrepreneur called Peter Lehrman who was part of the founding team at Gerson Lehrman Group (technology platform for on-demand business expertise).

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The VC business is finally being disrupted

Java Printing

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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.

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.






Angel List Uberizes the VC business with world’s largest seed fund

angel list

By Bernard Lunn

VC Funds act as intermediary between:

– Founders

– Limited Partners (LPs = the actual investors)

It is normal for intermediaries to be viewed unfavorably and for opaque “clubby” business models to be eventually replaced by networks and software that inject a new level of transparency and efficiency.

We have previously written about how Angel List is a game changer because of Syndicates.

With this announcement, Angel List has ratcheted up the game again. This is one more example of how once a business gets network effects it is game over for the old way of doing things – think Microsoft, Google, Facebook, Amazon, eBay, Alibaba, AirBnB and Uber.

The announcement of the world’s largest seed fund was made on the Angel List blog on 12th October

Your “shameless copy & paste blogger” has put the key bits from the announcement here for your convenience:

“CSC Upshot, a new venture capital firm, has raised a $400M fund to invest in startups on AngelList. This is the largest fund dedicated to seed-stage startups, ever.

CSC Upshot will primarily invest in syndicates led by experienced angels and VCs. It will help syndicates make larger, faster investments in early-stage startups and their follow-on rounds. It will also help promising new syndicates make investments while they’re building a backing from individual investors.

Syndicate leads will earn their full carry on CSC Upshot’s investments. Leads can accept or decline capital from CSC Upshot, just like any other backer. And CSC Upshot’s investments will leave room for individual investors.”

Here is why this is a game changer:

There is no AUM (Assets Under Management) Fee in Angel List

So a Seed Stage Fund like CSC Upshot is not motivated to raise bigger and bigger funds and migrate to later stage. Think about the 2 and 20 model in VC. Earning the 20% carry is hard – you have to find great ventures to invest in. Earning 2% on a $1 billion fund gets you $20m a year – just to keep the lights on.

Angel List Syndicates and Seed Funds investing in Syndicates kills the AUM model in VC investing. That is a big deal. LPs hate AUM fees.

The AUM model forces Funds to go to later stage. AngelBlog has the data. The money quote is here:

“It takes almost as much time to manage a $1-million investment as it does a $10-million investment.”

So it is even better to deploy capital in $100 million chunks. That forces you to the late stage.

That explains why the air is now escaping from the late stage investing bubble as ventures do the “new down round” which is now called an IPO. The inversion of norm (private valuations being high than public valuations) could never last. It is ending now.

CSC Upshot is interesting because this is smart money from China getting in the game:

“CSC Upshot is based in the U.S. and is independent of AngelList. Its general partners, Huoy-Ming Yeh and Veronica Wu, are both engineers with degrees from MIT and Berkeley. They have had long careers in technology and venture capital, including work at Tesla, Apple, SVB Venture Capital and PacRim Venture Partners.

The fund’s largest limited partner is CSC Group. Founded in 2000, it is one of China’s 3 largest private equity firms, with $12B under management.”

This is another First the Rest then the West story.

In February we pointed out that VC investing was looking increasingly crazy and chaotic These were signs of a business model being disrupted.

I predict one thing. CSC Upshot is not the last Seed Fund to invest in Angel List Syndicates.

The Uberization of the VC business is happening now. The only problem for us scribblers is do we say a business has been Angel Listed? It does not have the same ring as Amazoned or Uberized.

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

The Dog Food Story – Raising Money For Fintech On Crowdfunding Sites

My test was pretty cursory, the kind of quick test that entrepreneurs make when seeing whether to take the time to use a service.

I tested:

  • Angel List
  • Crowdcube
  • Seedrs

I make no apologies for not testing all the platforms. No busy entrepreneur would do that; crowdfunding is a network effects game. If I have missed one with huge traction, I hope somebody will tell me.

My test was the equivalent of the Page 1 of Google test that SEO and Content Marketing folks do. In this case I looked at Page 1 of Trending, specifically anything that I could reasonably categorize as Fintech (I am pretty liberal in my interpretation because “bits don’t stop at category borders” and big Fintech will acquire ventures in adjacent spaces or to fill out their product stack).

Here is what I found (dateline 11 Nov. 2014):

Angel List:

  • InDenero – SMB accounting
  • Neighborly – US Muni Bond marketplace
  • Bit Access – Bitcoin ATM


  • CrowdLords – Buy to Let marketplace
  • Trillion Fund – Crowdfunding for environmental & social ventures


  • None

I got two take-away insights (those quick insights that may or may not be correct but that matter because perception can very quickly become reality):

1. The two UK sites show the % towards funding goal. This is like Kickstarter. It is possible that Angel List does this for accredited HNW. One advice for entrepreneurs from people with experience of crowdfunding campaigns is to close something like 30% offline before you launch online. If investors see less than 10% they tend to get worried.

2. Different focus of Crowdcube and Seedrs. Seedrs and Angel List both seem to go for the high trajectory, big ambition “Silicon Valley style” startups. This is a high risk/high reward game for investors. Crowdcube looks more suited to the larger number of “more normal” businesses within a well-defined niche (but still a lot bigger than your average retail operation or life-style business). These might not get your A List VCs salivating, but there are way more of these businesses so this high volume strategy might be the smart choice if you run a crowd-funding platform.


Covestor Using The Follower Model in Public Equities

Angel List uses the Follower model in early stage ventures, to great effect.

Covestor is doing the same in public equities.

I have no data on how they are doing; however I notice that they have not raised a round for over a year. Companies with a lot of momentum tend to raise ever-bigger rounds at frequent intervals (or get acquired or go to IPO).

MyBankTracker has this rather negative review.

The market for public equities is far, far bigger than the market for early stage private companies. So, one might expect Covestor to be doing far better than Angel List. However, one of the lessons that Peter Thiel teaches at Stanford is to start in small markets.

In early stage private ventures, there are enough passionate and motivated Lead investors (they aspire to be VCs and have been locked out of the permanent aristocracy of VCs) and there are enough Followers investors who feel that all the best profits have been taken in the private markets before companies hit the IPO trail. That combination of motivations is fueling Angel List.

That combination of motivations is missing in the public markets. It should not be missing. A healthy public equities market is vital to a free enterprise society. That is why I think we have “the crushed dream of a democratized stock market” and why I keep banging the drum for XBRL. The Follower model makes total sense in Public Markets, but maybe the market is not quite ready yet? Or maybe nobody has got the formula right yet?



Why Angel List Syndicates Could Change The Asset Management Industry

Angel List Syndicates enables angels who want to be VCs to establish a track record and then be remunerated like VCs for taking the lead on a deal. Then Angel List takes care of the admin side of being a VC.

Most innovations that change the world look ridiculous at first – think Twitter, Facebook, YouTube, WordPress & PayPal.

The Angel List core idea is simple – they poached it from Twitter. It is the Follower model. How can something as simple as “Following” somebody change an industry as huge and complex as the Asset Management Industry?

Two stories will illustrate why:

Story # 1: Lloyds Insurance.

A long time ago, I had a friend who had a gopher job at Lloyds Insurance. He was a “runner”. He described how massively complex risk could be financed in a day. Imagine insuring a space rocket launch; how on earth do you figure out the risks? This was a real world example. Lloyds had lots of specialists in different domains. One of them was a space expert. He would set the rate, basically committing his investors to underwrite the risk (he was the GP in VC parlance). My friend would then walk/run around to all the other specialists who would only look at two things – the area of expertise and the expert. If those two lined up, the other specialists underwrote massive sums in an instant, just putting in an amount and signing their names. My friend and I were staggered by how much money was deployed in such a short time around hugely complex subjects.

Story # 2: Family Offices.

This was more recent. It was a networking event to discuss direct investing (i.e. buying equity in companies, not via a Fund). Each of the participants was asked to describe their Family Office and how they made their money. The range of expertise was wide. For example, one was an expert in property in Dallas, while another was an expert in Biotech. Both were super experts in their domain and had no knowledge outside that domain. So the simple idea was to “Follow” them in their domains.

What Angel List has done is make that easy. They take care of things like ensuring the money is wired, creating Special Purpose Vehicles, tracking investments and so on. These are mission critical tasks, but they are not competitive differentiators. Those details matter and they are complex; get a detail wrong and it’s a disaster. However, these details are not the judgment on whether to invest in Facebook vs Friendster. That is where the super-experts are the key.

The “super experts” are the specialists who really know their subject cold, who have done their 10,000 hours. They are the same folks that journalists court as sources and that you can follow on Twitter.

Like the space launch example, each venture has massive complexity and risk; but once the lead investor signs onto the deal, the others follow with their checkbooks open.

The VC industry – it is now an industry – has worked by herding those experts into a few funds. The funds were the gates to those experts and they charged a hefty toll to all – LP investors and entrepreneurs – for the privilege of getting access to those experts.

The folks running those funds were smart enough to know that they were not the 10,000 hours experts in all those specialist areas, so they invited those 10,000 hours super experts to co-invest in deals in their domain. This was a great win/win:

  • Fund got the insights and network of the super expert.
  • Super expert invested on same terms as the Fund, without any fees.

The VC business is subject to the most Darwinian power law. Both LPs and entrepreneurs know that the returns are massively skewed to a few elite firms. Most LPs don’t get access to these elite firms and investing in a startup fund is too big a risk for most LPs. This makes it very hard for new funds to get established and implies a “permanent aristocracy” of a few firms.

Angel List could change all of that.

Angel List Syndicates, with their simple Follower model, solves the biggest problem for all the market participants:

  • Investors who want to be active and take a lead role. Angel List Syndicates allow angels who want to be VC GPs (General Partners) to establish a track record and get paid on the profits made by the passive investors. It enables upstart VCs to get their foot on the first rung of the ladder.
  • Investors who want to be passive. This is the normal LP (Limited Partner role). Compared to investing in a traditional Fund, LPs who back an Angel List Syndicate get three benefits:
  1. Lower fees (no 2% of AUM and Carry that is about 50% less than the Fund norm of 20%)
  2. Less lock up – they commit one deal at a time.
  3. They get to choose which companies to back – they don’t have to back every deal that the GP likes.
  • Entrepreneurs who want the lead investor to be motivated. Finding the lead is the whole game for entrepreneurs. With the right lead, the round is oversubscribed and easily closed. Without a lead, entrepreneurs spin their wheels with a bunch of investors who are all waiting for somebody to take the lead. Angel List ensures that the lead investor is financially motivated to take the lead.

In my title I said that this was a game-changer for the Asset Management Industry. I deliberately did not limit this just to the VC early stage high trajectory industry. The basic idea of a Follower model applies more widely, as my two stories relate. To use Hedge Fund terminology, the domain expertise and network of the 10,000 hours super expert is “Alpha”.

The Follower model can work in public markets as well as private markets. It can work in debt, or in property, or in any domain where investing today is mostly done via Funds.

Angel List blows up the idea of a Fund in the same way that iTunes blew up the idea of an Album.

Moving into public equities will put Angel List in competition with firms like Covestor that already use the Follower model in public markets. Marketplaces are a network effects game. If Angel List gets great investors (both Lead and Follower), then moving into other asset classes will be easy.

The current asset management industry is based on asset class categories such as public vs private asset or debt vs equity or VC vs Leveraged Buyout. However, the two most fast-moving pools of capital – Hedge Funds and Family Offices – often operate thematically more than by asset class. They invest based on themes, such as a rising middle class in India, Healthech, Fintech, Edtech, urban property for Millenials or retirement homes for Baby Boomers. They care less about the stage (early stage, late stage, emerging growth public, late stage public) or the asset class (debt vs equity); those are rightly seen as subsidiary transactional issues related to specific issues such as cash flow and liquidity.

As Angel List (or other network/marketplace with a similar model) scales, the domains will get more and more specialized. Today, it is enough to be a specialist in Fintech. Tomorrow you might wany to follow somebody who is a specialist in a sub-sector such as Crowdfunding or SMB Lending or Consumer Lending. Or an expertise in Biotech might break down by disease or by market (how to market in the Rest is different from the West). Property investing is always local, so there is room for lots of experts. One can envisage thousands of sector experts to Follow.

Yesterday I looked at Seedrs. They have done the work that enables them to create something like Syndicates. It will be interesting to see how this plays out. Can Seedrs get traction in Angel List’s home turf (Silicon Valley) before Angel List comes to the UK?