Imagine you are a public market investor. Your entire portfolio holds only penny stocks. You're hoping for one of those investments to break through and return several times the investment, to make up for all the other losses. By the way, if you do pick winners, you won't be able to touch your money for nearly a decade.
This strategy works if it's a small part of your larger portfolio, but for most new venture--nearly all crowdfunding--investors, it comprises the entirety of their venture investments (successful seed stage companies take nearly a decade to see exit).
Now, imagine paying someone a finders' fee and carried interest for putting together that portfolio of penny stocks. That's the equivalent of "funds" and "syndicates" products available on crowdfunding websites that focus exclusively on early stage investments. Such asset class concentration (and fee structure) is rarely seen in the public market, but is all too common in the private, venture market.
Angel Investing (Online)
As equity crowdfunding grows, mind share (and portfolio-share) taken up by angel investing has never been larger. According to Forbes, in 2013 the world saw over $5.1B of capital deployed via crowdfunded platforms--that is 89% higher compared to that in 2012.
While impressive at a high level, even a cursory investigation into this figure reveals a terrifying trend. Investors using these crowdfunding platforms are creating heavily concentrated portfolios, putting all their eggs in one basket. The basket is the asset class of early-stage (pre-Series B) venture-backed technology companies.
So, if you are one of the investors who believe that angel investing equals seed investing, you're missing out.
The Case for Diversification
As Wall Street Journal reports, 95% of new businesses fail to meet their projected return on investment, and it is widely accepted that nearly 80% fail to return altogether. By comparison, Crunchbase's data suggests only 3% of companies that have raised $90M+ fail, and over 80% are still operating including in public markets.
With such a stunning difference in success rates, it is clear late-stage VC backed companies have different risk profiles than do early-stage ones. Investors should be aware of diversification avenues available to them: later stage venture-backed investments.
"But, I don't have millions to invest. Can I still invest in later stage venture-backed companies?"
Yes! Platforms, like EquityZen (disclaimer: I'm affiliated), that allow you to invest in secondary offerings in companies past their Series B financing offer a valuable means of diversifying your venture portfolio. In the public market analogy, it is like adding some blue chip, growth, and value names to your portfolio of penny stocks.
Never Too Big To Fail (in VC Asset Class)
Recent news of Fab's fire sale and Aereo's bankruptcy filing sent a jolt through the startup world. As discussed in the first part of this series, startup shareholders--employees and founders alike--should take heed. Diversification matters. Investors, too, benefit from diversification.
"Wait, Fab and Aereo failed--isn't article about how good late-stage companies are?"
The value of any investment can go to zero. Don't let anyone tell you otherwise. The same is true for venture investments in young and old companies, alike. Fab and Aereo serve as a reminder that investments in even larger venture companies can plummet.
Venture investing, especially early stage venture, is for people who can withstand 100% on their investment. However, the vast majority of later stage venture companies have positive outcomes and until recently, you did not have a venue through which you could access such investments. Institutional Venture Partners, which invests almost exclusively in this late stage VC backed firms, has exited via IPO for 100 out of 300 investments in their portfolio.
What's more? In addition to diversifying your portfolio with later-stage VC investments, you can also diversify by getting cash for otherwise illiquid investments.
Liquidity Solutions Before Exit
Put yourself in the shoes of the angel investor in Aereo. You invested in Aereo because you believed in the company. Until 2013, you saw your angel investment skyrocket in value to 35x your initial investment amount (Apr 2011 through Jan 2014 saw Aereo's share price go from $0.11 to $3.88/share). When the regulatory battle in 2013 and 2014 heated up, the firm and large investors doubled down.
If you were not comfortable with that move, in public markets you could have sold your 35x holdings. Until a few years ago, you would have no options, but to hold it until exit (or bankruptcy).
Private secondary markets are only now maturing and you can use platforms like EquityZen to divest some portion of your holdings cash before the IPO. This is not to say it's a market for lemons--there must be buyers seeking access at the same price for the same investment. But, it's an option you never had before.
Secondary platforms are serving a much-needed function in solving the very problem of diversification. As secondary markets evolve, don't miss out by thinking venture investing is limited to seed stage.