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Sunday
Jul192009

Another Take on Crowdsourcing Venture

The venture capital model is not dead. Its time to end the back and forth already and move on with it (at this point, I might even be beating a dead horse just mentioning how it’s talked about too much). To recap: the major issue is that there's too much capital (for many reasons) chasing too few good deals. As a result, many firms will flounder due to poor performance, and those that have raised large funds will probably face difficulties. The amount committed to venture capital as an asset class by institutional investors will drop and so will the number of and amount invested into startups. But all this does not mean the venture capital model is dead. Instead, think of it as creative destruction as the venture capital model continues to evolve. Yes - not death, not maintaining the status quo (for sure), but good old evolution. The evolution will of course involve attrition and a shift back to basics, but it also means that there will be openings for new and interesting investment models to come forward.

A while back, I explored the possibility of crowdsourcing venture capital. I still think this idea has some legs; in fact some form of crowdsourcing will almost certainly be part of the evolution of the venture capital model. Since my last post on the topic, I've discovered many other attempts at similar models, but none that have truly succeeded. A good way to think about crowdsourcing venture is to frame it as a wiki - VentureDig does a great job of explaining this model (worth a read, good comments too). In this sense, any number of individuals could directly invest in startups they choose, allowing the collective wisdom of the crowd to ultimately choose the best companies and provide them with the capital they need to grow. While there are legal issues around this model (the SEC, but let’s assume that there are ways around them), it makes sense intuitively and probably would work well for web startups, particularly those that were previously bootstrapped.

The issue I see with wiki model though is that I think it tries to make the leap to giving power to the crowd too aggressively. Remember, the venture model just needs to evolve, not change completely. With that in mind, I think it’s important to stick to some form of how venture capital funds are currently structured, but change the way investments are sourced, diligenced, made and managed. That last part is key, because one of the key components of venture investing is managing companies post investment. This is why we still need venture capitalists and why any crowd sourced venture capital entity needs to be structured as a fund - so that the collective wisdom of the crowds can actually influence a company's growth. Here are a few more reasons why I think capital still needs to be pooled in order to be effective in making venture type investments:

  • Pooling capital eliminates the need to attract enough individuals to make an impactful level of investment - its much tougher to get, say, a thousand one, two or three thousand dollar investments than it is to get a single investment of one, two or three million dollars.
  • Pooling capital allows for the accountability of entrepreneurs - a set of individual investors do not have the power to hold entrepreneurs accountable once they have invested, but if you pool capital and act as one, you can.
  • Confidentiality issues are avoided - no need for startups to send out agreements and diligence documents to thousands of investors.

With these points in mind, how would I ideally go about crowd sourced venture investing? I would not have any type of competition or structure it as a private exchange or even list an entity publicly – all ideas that have been tried before. Instead, I would have a general partner consisting of actual venture capitalists and a limited partner base of thousands of individuals, each contributing somewhere between one and 10 thousand dollars. But these would be no ordinary limited partners. They would be active in the investment decisions made by the fund through voting and collaboration through a messaging system. The fund would be totally web-based and investors would be encouraged to offer suggestions and the venture capitalists would maintain an open dialogue with investors.

Admittedly, this idea of what a crowd sourced venture fund should be is quite idyllic, but if we are to bridge the disconnect that exists between venture capitalists, entrepreneurs, and the tech community the venture model needs to evolve such a way. As the world moves towards more openness and collaboration, it’s inevitable that some of it will creep into the venture model, it’s just a question of how.

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