It’s taken me a couple of years to grapple with this but let’s just put this out there: fundraising in the Silicon Valley is very much a game of pedigree. It’s something that startup investors talk about in vague terms. Investors say things like: “This founder is very fundable” or “This founder doesn’t pattern match.” Ellen Pao talks about this explicitly in the excerpt of her new book, Reset:
Predicting who will succeed is an imperfect art, but also, sometimes, a self-fulfilling prophecy. When venture capitalists say — and they do say — “We think it’s young white men, ideally Ivy League dropouts, who are the safest bets,” then invest only in young white men with Ivy League backgrounds, of course young white men with Ivy League backgrounds are the only ones who make money for them. They’re also the only ones who lose money for them.
This is an incredibly telling statement. As an early stage investor, I know that if I can invest in a team that fits exactly what Ellen describes (or MIT/Stanford, or Facebook/ Google), I’ll win in the short term. It doesn’t really matter what the team is doing or how well they execute. I know that some investor down the road is going to be enamored with the team’s resume, pick up that team at a higher valuation, and fund them. In fact, I’ve seen this happen over and over with my portfolio companies who have pedigree – even with the teams that are not able to execute well! And since gains in most investors’ portfolios are on paper only and are not realized for 7-10 years, executing on this strategy is a short term win for early stage investors such as myself, even if companies die 5-7 years later!
Knowing that, you have to believe that your portfolio companies can get downstream capital because, as a small investor, you won’t be able to invest at the series A round and beyond to carry your companies forward. So if you are interested in investing in a company that doesn’t fit the “classic pattern,” then you have to think through all the scenarios if such a company is not able to raise money. You have to have so much conviction that the company will survive through all the tough years before traction really takes off. You have to believe that the founders are willing to eat glass for breakfast every day – 100x more than a team that can easily get VC investment. In other words, the teams I’ve backed who do not have pedigree are 100x more tenacious and stronger than those with pedigree. I’m aware that the world will treat some of my children more harshly than others simply because of the way they look or sound or where they went to school or didn’t go to school.
It isn’t fair. But it’s business. And that’s how things are. Today.
I’m optimistic the world is changing, and it’s changing at a faster pace than ever before. Just a couple of years ago, AngelList announced their syndicate feature. This allowed angel investors to accumulate more fire power behind their small checks. Gil Penchina, for example, a rainmaker angel investor, could get his 99 friends to invest alongside him, which brings his total investment power to millions of dollars. This was an incredible innovation in startup investing. It meant that small investors could essentially band together to lead a series A round. Small investors could have conviction in companies where traditional VCs do not.
This is just the first step. By democratizing money – i.e. truly commoditizing money – it means that founders not only need not rely on the 50 or so Silicon Valley VC firms for serious cash, but it also means that a lot of companies that are growing quickly but don’t fit the right “pattern” VCs are looking for will be able to get funded by others who have conviction in their businesses.
Syndicates are logistically challenging. You have to rally all of your 99 angel friends to participate. And if they don’t, you still don’t have a lot of fire power alongside your small check. Frankly, most of the time, your friends are too busy to partake and to be evaluating all these deals, since this is not their full time job. Moreover, as a founder, often you are limited to only fundraising from one syndicate at a given time, which limits the number of groups of people you can raise from. Moreover, these syndicates are often limited to investors from certain geographies by both legal and practical reasons. Net-net, syndicates have increased the power of small investors by a lot for some, but for most small investors, they still do not have enough money behind them to be able to lead rounds.
Enter ICOs (initial coin offerings).
The Benefits of ICOs
I’m incredibly bullish that ICOs will really empower all kinds of investors – large and small – to make investments in founders in whom they have conviction without caring if the 50 Silicon Valley VCs will have that same conviction (or if they’re conflicted out). Although tokens will be subject to securities laws, I think ICOs will provide the following benefits:
1. Greater geographical access.
In other words, investors from other parts of the world or even within the States (both big and small investors) could partake in fundraising rounds in Silicon Valley and vice versa. Today many people simply don’t have access to deals being done here in the Valley.
2. More efficient infrastructure.
Today, there is a lot of friction and just general inefficient infrastructure around deals. ICOs circumvent problems that you find with traditional banks – wire cutoff times, wire fees, currency exchange rates & fees (to a certain extent), in some cases, legal paper work printed and physically signed. Technology, in general, is a good way to get rid of anachronistic practices. Why are there wire cutoff times in this day and age? I’ve been told that some microfunds pick their banking partner partly based on the wire cutoff times. Shouldn’t everything run 24/7 now?
3. Objectivity in evaluating companies.
Founders won’t be judged on appearances. When you walk into a typical VC office today, if you’re tall and have a booming voice, you’re already at an advantage. Online, none of this matters. No one cares if you’re good looking or can talk well or if you’re tall or if you’re pregnant. All that matters is that you can run your business well. This is the promise that I see in ICOs – that you’ll be judged by your execution and merit rather than by how you look and sound. We’re still VERY FAR OFF from this vision, and many of the pieces that are needed to get to this point don’t exist today. However, this is the direction that I see ICOs going in. We are living in a new, incredibly fast-paced era for startups, and I am so excited to see the playing field finally start to level out for entrepreneurs everywhere.