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A digital VC market

1 November, 2015

For the last five years or so there has been a lot of buzz about software-driven innovation in the venture capital industry. Innovations such as AngelList syndicates, crowdfunding, and digital M&A marketplaces play an increasing role. The USA is leading this development, predominantly in seed stage investing.

But by and large, today’s VC industry remains “business as usual”. We’ve recently seen the launch of so called “quantitative funds”, but this an incremental change; not a game-changer for capital markets as a whole. In this post I will argue why such change hasn’t happened yet, why it would be beneficial, and what is required to make change finally happen.

Let’s for a moment look at the public stock market. Today, public stock markets are fully electronic, but they used to have an open outcry system. Traders used shouting and hand gestures to communicate pricing and give buy/sell orders (remember that brilliant movie Trading Places?). It took most stock markets an awful long-time to finally switch to electronic trading platforms. The New York Stock Exchange only converted as late as 2006! A notable exception is the London Stock Exchange which converted early on in 1986.

What took Wall Street so long? The answer is that financial markets were held back by special interest groups wanting to keep open outcry in place, as it gave many people very lucrative jobs, and kept the market opaque enough to maintain higher margins for insiders. The eventual catalyst to convert came in the form of a new special business interest. High frequency traders and the hedge fund industry created a new revenue stream: providing “VIP” services to hedge funds (high-speed access stock to exchanges), combined with  increased volumes from high frequency trading would eventually dwarf the old market making industry by revenues.

So what could be a similar catalyst for change in the venture capital and private equity industry? The following special interests could play role, ranked by order of likely influence:

  • Young but big private companies that are not ready to go public due to their high investment requirements and short financial history
  • Fund managers, who traditionally invested via venture capital funds as LPs, require more flexibility to invest and divest
  • Blockchain technology could help create a global clearing and settlement system that is both global and decentralised at the same time
  • The advent of crowdfunding

is a digital VC market useful? There would be huge efficiency agains for sure. There’s a potential to create combine the best attributes from public market and private market investing. Here’s what a true digital venture capital market could look like:

  • Electronic transfer of shares
  • An electronic ledger for clearing and settlement, possibly using blockchain technology (but not necessarily)
  • Standardised financial and operating reporting (1)
  • Widely syndicated deals become the norm, individual large bets the exception
  • Self-reporting: no obligation to file, but a strong incentive
  • Global access to company data on request, as and when needed (qualified investors only, not the entire general public per se)

Note 1 : Accounting standards exist of course, but for private companies these are once a year occurrences, and not much good for VC investing. Here we are talking about a standardised set of quarterly management reports including basic VC-style KPIs. This is inevitable as data acquired through artificial intelligence would otherwise overshadow self-reported figures and companies loose control over their reporting.