This week's Future of Fintech is on the future of private equity funding, discussing why PE has become such a hot space, how more people can become venture investors, the challenges of innovating PE, regulating the PE space, the crowdfunding experience, types of businesses that do well on crowdfunding platforms, and much more.
Guests this week include:
- Nicholas Tommarello, Founder & CEO at Wefunder
- Elizabeth Yin, General Partner at Hustle Fund
- Avlok Kohli, CEO of AngelList Venture
- Sahil Lavingia, Founder & CEO of Gumroad
Highlights from Future of Fintech: Private Equity Funding
This interview has been lightly edited for length and clarity.
This space seems hot recently. Why are people so excited about private equity funding?
NICK (Wefunder): We started Wefunder back in 2012. When we first started the company, we helped congress pass the Jobs Act. It took another few years until those laws rolled out for equity crowdfunding, where anybody could invest. But it wasn't until last week where those laws became workable. Companies can now raise up to $5 million per year, instead of just $1 million, from unaccredited investors.
More importantly, single purpose vehicles are now available for unaccredited investors to invest in, whereas last year you'd need ~3000 direct investors in your cap table. More mature companies are willing to crowdfund now.
AVLOK (AngelList): We focus on reducing friction, so more people can become venture investors. Traditionally, to get into VC, you’d have to join a traditional fund, get a crack record, and make investments. When you spin off, you traditionally raise from an institutional LP; you need an anchor LP to get started.
Fast forward to today, you can get started with a rolling fund: you can tweet it out, and the LP network comes to you. Having more founders and operators become VCs is one of our biggest flywheels.
The other is that the nature of tech has accelerated, post pandemic. Venture is private tech investing. There's a lot of capital looking for a place to grow. That's the other big flywheel.
AngelList had syndicates and funds for a while, but no one would talk about them until the rolling fund came out. Was the fact that people were raising publicly integral to the success of rolling funds?
AVLOK (AngelList): Venture fundraising has been a dark art. You usually have to go through networks, and take coffee and zoom meetings.
But for the first time ever, since the rolling fund is public, people are talking about it publicly. That inspires the next generation of GPs to look at someone raising and go, "I can get a rolling fund started. I can tweet it out. I can do that."
Rolling funds are continuing to increase exponentially, because every rolling fund is inspiring another set of people to raise more rolling funds.
How big are rolling funds now? How many of them are there, and what's the biggest one?
AVLOK (AngelList): It's well past 100 today, but we haven't shared the exact number. The largest fund we have is the equivalent of a $120 million fund, if you compare it to a traditional fund. We have multiple rolling funds that are scaling quickly.
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Is the limitation of 99 accredited investors a major limiting factor to large funds?
AVLOK (AngelList): That is always going to be the limiting factor for any fund, whether it's a traditional or a rolling fund. The SEC has guidelines around the number of accredited investors you can actually have in a fund, and it's 99.
Now, if you only have a QP (qualified purchasers, these are LPs and people who have a net worth of $5 million and above) fund, you can have 1,999 LPs.
If you're looking to grow your LP base, we'll set up parallel funds so you can have almost 2000 qualified purchaser LPs in one fund, and 99 non-qualified purchasers in another. We’ve built in optimization to allow GPs to scale capital quickly.
Nick: your limiting factor is getting enough companies to want to fundraise, right? It feels like the two of you have different limiting factors.
NICK (Wefunder): Yeah, that's correct.
Elizabeth and Sheel: you are full-time investors. Do you think it is a negative signal for a company to do crowdfunding?
SHEEL (Better Tomorrow Ventures): It depends on the type of crowdfunding. It feels like there's some negative signaling.
AngelList is different: there's a syndicate lead and AngelList has a track record. I myself have raised and deployed on AngelList. For some other platforms, where the company is just posted up, there is a question of “could you not raise elsewhere?”
NICK (Wefunder): Over the last four years there's been adverse selection on companies that have crowdfunded; it’s more likely that they could not raise money elsewhere. And every year there are outliers who, for ideological reasons, wanted their customers to be owners.
What we're seeing now is that the fundamentals have changed. Since the law has changed, that (negative) signaling will gradually go away as more good companies take advantage of these laws.
ELIZABETH (Hustle Fund): Branding is another factor. With $5 million raises possible now, companies at later stages can raise. Wefunder and Gumroad are great examples of larger raises with brand recognition. Brand recognition gives investors more confidence.
SHEEL (Better Tomorrow Ventures): Something I'm particularly excited about is what Gagan Biyani's new company did: they had a traditional fundraise with leads, and then they took applications for more people to put in money. You can use crowdfunding to bring more supporters into your company and make it a relatively painless process. You could add customers who've been wanting to invest in you, but don’t make sense to put on the cap table.
Does Wefunder go through legal reviews for crowdfunding campaigns?
NICK (Wefunder): Yes, through the SPV. We'll have an in-house team look at the doc to the lead investor sides.
ELIZABETH (Hustle Fund): I'm pro-crowdfunding and democratization, but VC funds have access to lawyers. We pay for lawyers. As a retail investor, I don't have a lawyer. There are some things that are not quite apples to apples, where retail investors can get hosed in a way that a VC can't.
NICK (Wefunder): The design challenge for Wefunder is to harness the wisdom of the crowd alongside the wisdom of the elites. The way forward is having lead investors and investor panelists give input, and using standard contracts.
Where is Wefunder going?
NICK (Wefunder): We finally have the changes we need to make crowdfunding a workable offering that companies want to use.
Probably the other change will be around the test to become accredited. In October, the SEC released the first incremental change to how an individual who is not wealthy can prove they are sophisticated. Imagine if in the next couple of years, there was a more common sense way to becoming an accredited investor. That would help us upgrade our million investors, where some subsections could become accredited.
Maybe in the next five years, it'll be more commonplace for companies to raise up to $75 million from unaccredited investors. If that happens, then Wefunder is doing IPOs as they were done in the '90s: much smaller IPOs of maybe $100 million dollars. I see regulation crowdfunding as us starting that journey.
Can Wefunder do secondaries?
NICK (Wefunder): With regulation crowdfunding, you can do secondaries one year after the primary offering. I'd expect the secondary market to emerge after a couple of potential unicorns.
So basically you think the line between public companies and private companies is blurring?
NICK (Wefunder): Yeah, that's exactly it. For 80 years, we had private markets and public markets, and it was one or the other. In the last five or six years, you can have a legally-private offering, but it's very public because you get to advertise and take out random people as investors.
What I would like to see this evolve into is another category where you raise your first few thousand dollars from angel investors, and then use regulation crowdfunding to raise $5-10 million for your Series A. But it is known as a new stock market that is known to be riskier, so there are investment limitations, and people are not allowed to invest more money than they can afford to lose.
But, in turn, there are less regulations (no Sarbanes-Oxley). So, companies would be willing to do this. Then the question is, “how can you design the secondary market to encourage long-term thinking?” So, perhaps you have liquidity events every 9-18 months that line up with traditional fundraising.
ELIZABETH (Hustle Fund): Everybody strives for truly free markets. The public market is mostly truly free; everyone knows what companies are there and anybody can go and buy. The private markets are very opaque. That's why funds like mine needed 700 meetings with investors. It's partly because we didn't know which investors were interested, but Avlok is trying to solve for that. I would take a more bold stance and say that this could disrupt VC. The best VCs will stick around for a while, but it is actually a real possibility.
Naval is into separating capital and advice: VCs will get a bigger share and give advice, and capital will come from a distributed source. Is AngelList headed in that direction?
AVLOK (AngelList): That maps to how we think as well. As we think about separating capital and advice, there's also a signaling job to be done. When founders raise capital at the very early stages, they solve for multiple things, including signaling (“am I an attractive company or not?”) If you can get one of the brand name investors to invest in you, that's a signal which reduces the transaction cost for other investors to engage with you. Then you can create that momentum and fundraise. Now, there's an open question of how do you price that? Do you have everyone investing at the same terms, the same cap?
What is interesting about crowdfunding is that you can get your customers to actually invest in your company, and then become evangelists of your company. We're seeing it in full force right now in crypto. People that have skin in the game are promoting their favorite projects. I'm curious to see how that plays out with crowdfunding as well.
NICK (Wefunder): That is exactly what Wefunder has done for itself over the last nine years. We have no institutional investors. 99% of our investors went to wefunder.com/wefunder and typed in a number to invest. We’ve raised $20 million over the last nine years without working hard for it. We tell our users that they can invest in a product they already know, understand, and love.
ELIZABETH (Hustle Fund): I would say that the trend is happening in the opposite way. It's not a separation of money, advice, and signal. It's actually combining them. In an ideal world, if you have so much demand, you would pick the investors who can bring more to the table than money. We're already seeing this happen with the rise of operator angels and fund managers. They're putting in relatively small checks, but are also valuable in other ways. I would love to fill my fund or round with those people. That's why I think that there's a real chance that VCs can be disrupted, at least for the hottest companies.
Sahil, you just raised 5 million for Gumroad. What were your positives and negatives from the crowdfunding experience?
SAHIL (Gumroad): Negatives: it's more burdensome than doing a rolling safe with accredited investors. It costs a bit of money and time. I had to have phone calls with lawyers and a third-party audit that anyone can go read.
Besides that, being able to raise $5 million from 7,000 different individuals is satisfying. It’s a new party round.
But what’s different is you had no lead investor, right?
SAHIL (Gumroad): I had Naval and Jason Fried put in a million bucks. Signaling, building momentum, and optics are key, even with crowdfunding. That's why I selected Naval and Jason Fried as poster children. I wanted people from two very different camps to show that this was the third way. It solved the price issue as well. For me it was important to say, "Look, you get to co-invest with Naval and Jason." You're investing at the same terms.
Long-term, I don’t think VCs will get exterminated by crowdfunding. But the people who are really adding value, might have a higher check size or get warrants or advisory shares. If I have 7,300 new investors, and 30 of them are insanely valuable, I can always issue them advisory shares in the company. I think that will effectively reduce the cost per share that they put in.
What businesses do well on Wefunder?
NICK (Wefunder): There's three sweet spots. Any company that has a dedicated fan base of users who are very passionate about the product, or the brewery or the store they go into, almost always works. The second category is things that are really hard tech, that a team of smart people are working on. It might not be venture-fundable yet because it's so hard. We've had cures for cancer in dogs, fusion reactors, administrator thrusters for satellites—things people want to support with a few hundred dollars that are risky. The third category is if it is obvious that you’re printing money or growing, that also always works.
Elizabeth or Sheel, would you recommend crowdfunding to any of your portfolio companies?
ELIZABETH (Hustle Fund): A couple of our portfolio companies have already done crowdfunding campaigns. They both actually did really well. For the right type of business, it can be great again to bring in customers and have them get skin in the game.
SHEEL (Better Tomorrow Ventures): I would love for there to be a product that allows 10% of the round to be reserved for fans of the company, and for that to be crowdfunded. And being able to do that through an AngelList syndicate, if there was a more streamlined way for them to allow anyone to invest, would be cool.
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The Mercury Team