Simon Cook, CEO of leading VC firm Draper Esprit wrote this guest post, originally featured in City A.M., exploring the evolution of the equity investment landscape and discussing how venture capitalists and the crowd can work together. Draper Esprit are no strangers to equity crowdfunding investing in Seedrs Alumni Perkbox in November 2016.
Maybe you’re just not ready for venture capital”, said William H Draper to a potential partner. It was 1959, and the now-legendary VC was trying to persuade a firm to invest in his new fund. Set up as a limited partnership, it was different to any other investment opportunity then on the market.
General William H Draper, the grandfather of our founder Tim Draper, was the former undersecretary of the US Army and the man responsible for the economic reconstruction of Germany and Japan under the Marshall Plan. He was also responsible for establishing the first venture capital firm in Palo Alto, bringing money, as long-time entrepreneur Chong Moon Lee puts it, to the “brash young technologists who were using bits of silicon to create an information revolution as profound as the industrial revolution a century earlier”.
There had been other examples of venture capital before this. In France there was the entrepreneurial bank Credit Mobilier, established in 1852. While in 1946 in Boston, JH Whitney & Co opened their doors with $10m to invest in new business models. But the novelty of Draper’s new fund, Draper, Gaither & Anderson, was how it invented a fundamentally different model of investment. The venture capital fund enables private investors to take an ownership stake in early-stage businesses, providing capital in anticipation of an exit.
The model is important because, left largely unchanged, it has become the norm in the VC world. Limited partnerships place pressure on the fund to show returns within five to 10 years, and they clearly work, for many have raised capital for some of the biggest success stories that have sprung from Silicon Valley, and indeed the rest of the world. The firm at the table with Draper in 1957 did, by the way, sign up to the limited partnership.
Designed for the future
But there is a key problem with this model. The benefits of high-growth companies such as Google or Skype are reaped primarily by private investors with access to large portions of capital. Whereas in the twentieth century, the companies that brought in the most money also employed the most people, the tech firms of today are reversing this trend. In 1962, General Motors, one of the top five companies by market capitalisation, employed more than half a million workers. Today, four of the top five companies (Apple, Google, Exxon and Microsoft) have a combined total of 300,000 employees. The financial benefit of these companies, then, lies primarily with their investors. We need a new way of distributing the wealth that private investors enjoy.
Crowdfunding doesn’t just enable entrepreneurs to raise money from potential customers while enabling them to create new businesses. When managed correctly, it also gives members of the public a chance to reap the rewards of high-growth businesses. Private investors play a critical role, but they need not be the only investors at the table.
It’s no secret that individual startups are a higher risk investment, requiring a portfolio approach. Whereas the crowd is reliant on the platform to mitigate initial risk in advance of a proposition being pitched, VCs mitigate risk through managing their portfolio closely. Good VCs will be magnets for excellent networks of advisers, talent and management experience – they answer the phone at 2am on a Saturday night during the inevitable tough times.
If you’re a member of the public wanting to invest in a new company, you may not have the level of expertise or global networks that venture funds can offer. That being said, investors using crowdfunding platforms do have a vested interest and frequently become valued mentors or advisory board members. Crowdfunding turns excited investors into powerful advocates, potential customers, and happy beta testers. Combined, VCs and the crowd offer entrepreneurs a potent platform to begin their business.
This is why VC firms like ours are changing in several critical ways. The first change we’re making is to regularly invest alongside the crowd – we’ve been doing so on platform Seedrs, on the same terms as their investors. This enables those of you investing using platforms to invest in a company which is also being buoyed by the networks, management advice and guidance of a seasoned VC. This is surely a win-win for everyone.
Second, we decided to innovate the venture capital model and publicly list ourselves. It probably sounds oxymoronic, but we did this to open up the VC model further to public investors: anyone can now invest in our portfolio of fast growing companies, from PushDoctor to Perkbox. It also enables us to provide patient capital to entrepreneurs. The typical model of the five plus five-year limited partnership means showing returns quickly. We know that the best global businesses take much longer to build to their maximum potential. Going public ensures our portfolio companies don’t have to until they’re ready.
We are in the early, pioneering stage of crowdfunding and of public, patient capital models. There is risk involved in investing in a new way. But as technology is opening up the way we communicate, the way we connect, the way we learn, so too will it demand we open up the way we invest. We are strong believers that VCs, angels and the crowd can work together to provide the right long-term patient capital for the best entrepreneurs. Together we can empower teams to build global companies that last, and for that benefit to be enjoyed more widely.