In yesterday’s column, I explained how traditional venture capital (VC) investors have become apathetic. They’re not plowing capital into private VC funds with enthusiasm anymore.
We can blame the high fees, decades-long holding periods, or terrible investing results. Take your pick. But pushing the blame around doesn’t change the fact that the VC model is broken.
On the other hand, through crowdfunding platforms like Kickstarter, individual investors can’t make it rain enough for all sorts of zany projects.
For instance, an art project commenting on the ancient origins of modern Japanese game culture recently raised over $300,000 in financing. (No joke.) And a REM sleep-enhancing mask raised almost $600,000. (Again, not a joke.)
If only venture capital firms could tap into the public’s fervent appetite to fund startups, the industry might be revitalized.
And wouldn’t you know it? That’s precisely what’s about to start happening. Wall Street is about to be ground zero for a trillion-dollar transfer of wealth from private venture capital deals to public VC.
The shift could prove to be one of the greatest equalizers in history, providing everyday investors with access to previously unheard-of profit opportunities, particularly in the technology sector.
On such merits, it’s imperative that we start preparing for it.
Before I share how we do that, though, let me first reveal the most critical market condition that’s about to come to pass and, in turn, usher in this massive wealth shift.
Believe it or not, we have the government to thank for it.
For Once, the Government is Helping (Not Hurting) Investors
Historically, new government regulations precede booms in VC funding.
In 1958, the Small Business Investment Act allowed the Small Business Administration (SBA) to start licensing private investment firms to help finance and manage small companies in the United States. Lo and behold, the very next year, the first venture-backed startup, Fairchild Semiconductor, was funded.
Then, in 1978, the U.S. Labor Department relaxed restrictions in the Employee Retirement Income Security Act (ERISA), allowing corporate pension funds to invest in privately held companies. And that year, the VC industry raised a record $750 million. Coincidence? I think not.
And I’m convinced we’re about to experience another government-induced capital influx, courtesy of the Jumpstart Our Business Startups (JOBS) Act.
Signed into law in April 2012, the JOBS Act contains many changes that impact financial markets.
I already told you about the provision allowing “emerging growth companies” – startups with less than $1 billion in annual revenue – to file secret S-1 forms with the SEC.
Well, another significant provision of the legislation involves the restrictions regarding how private companies can seek funding. No longer will they be forced to rely solely on “accredited investors” (i.e. – the 1%).
Instead, they’ll soon be able to solicit funds from the 99%. So those making less than $100,000 per year can invest up to 5% of their income, and those making more than $100,000 can invest up to 10%.
Simply put, private companies (and VC funds, for that matter) are about to have much more access to individual investors and their bank accounts.
The only thing holding back the floodwaters is the SEC.
Per Congress’ instruction, before the new changes for equity crowdfunding in the JOBS Act can go into effect, the SEC needs to set up regulations to protect the public when investing in small businesses.
The SEC’s deadline was supposed to be January 2013, which has obviously passed. But they’ll act soon enough. So it’s only a matter of time before crowdfunding enters the mainstream.
It’s a Re-Birth, Not a Death
Let me be clear - I’m not suggesting that venture capital is a goner. Or that traditional VC funds are about to be replaced by a younger, fitter, more agile generation of financiers.
I’m merely predicting that venture capital is about to be reborn.
While crowdfunding platforms provide unparalleled access to public funding, they possess major drawbacks. Namely, they’re too successful and none of the projects are vetted.
Projects on Kickstarter routinely raise way more than they originally requested. The two examples I shared above raised 3,012% and 1,636% more money than they requested, respectively.
Throwing too much capital at a business owner is never a good investment strategy. In some cases, it creates more problems than it solves.
Take Tigere Chiriga, for example. He set out to raise $15,000 to bankroll his invention – a coffee mug that doesn’t leave moisture rings on tables. As Entrepreneur magazine notes, he ended up raising $40,000, and suddenly “his one-man operation needed a manufacturer and logistics house that could handle shipping.”
In Chiriga’s own words, “I had 30 days to become proficient in manufacturing, warehousing, packaging, fulfillment, retail, e-commerce, customer service and marketing.”
Can you say mission impossible?
I’m sorry, but as an investor, I don’t want my hard-earned capital being spent on training an executive. I want it to be used by seasoned professionals to execute on an unprecedented opportunity. And that brings us to another drawback of popular crowdfunding platforms…
Many of the “executives” behind the most popular crowdfunded projects couldn’t operate a pay toilet, let alone run a publicly traded company with thousands of shareholders. So, ultimately, Kickstarter amounts to nothing more than a dating platform, matching cash-starved projects with cash-flush suckers.
So forget about crowdfunding replacing VC firms. These drawbacks actually underscore why we desperately need VC firms to lead the public venture transfer.
You see, VC firms don’t just fund a project and pray that it works out. Heck no! They get dirty and do a lot of heavy lifting for investors.
They vet opportunities before even considering investing a single penny. They insist on getting seats on the board. They actively engage management. They’ll even recruit key talent, which proves vital to a company’s (and investors’) long-term profitability.
I’d much rather entrust my capital to their model, as opposed to an offshoot of Kickstarter. Wouldn’t you?
Bottom line: Public venture promises to be the next big thing. It’s the only way to fix the broken venture capital model. Even the Kauffman Foundation, with $2 billion in assets, admits that it needs to start moving “a portion of capital invested in VC into the public markets.”
In addition to the institutional demand, the public has obviously demonstrated a rabid appetite to fund startups, too. And once the SEC gets off its duff and passes the necessary regulations, it’s going to open up the possibility to tap individual investors to fund legitimate opportunities.
And if we want to be on the right side of this wealth transfer, we need to be on the lookout for Wall Street firms pioneering the change. They’ll be the ones bringing public venture opportunities to market via reverse mergers and IPOs.
MDB Capital Group is certainly leading the charge in this respect. In fact, its latest company presentation speaks directly to a public venture model.
Canaccord Wealth Management also appears to offer public venture capital opportunities to select clients.
I guarantee many more firms are going to swarm the opportunity, once the SEC announces its regulations. I’ll be on the lookout for them and promise to alert you to specific opportunities along the way.