Early-stage private capital markets are moving online. How about later-stage?
May 08, 2014 11:00 am | Jonathan Sandlund |View Original Post|
Offerboard unveiled its online private placement platform at TechCrunch Disrupt earlier this week. Aiming to facilitate transactions between $2-25 million, and expecting an average transaction around $10M, Offerboard is not just another early-stage equity crowdfunding platform. It’s appetite goes much higher up the food chain.
It got me thinking about how equity crowdfunding—or perhaps more aptly, online private capital markets—may evolve in the coming years. Today, global equity crowdfunding infrastructure is predominantly seed and early-stage focused. This isn’t a negative, and certainly not surprising. It’s a natural starting point for the new capital-formation kid on the block, and her behavior exhibits a pattern we’ve witnessed many times before.
Characteristics of disruptive businesses, at least in their initial stages, can include: lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics. — Clayton Christensen
To quantify this “early-stage” focus I pulled together a sample of European platforms that have completed at least 10 transactions. Let’s have a look.
European Equity Crowdfunding Platforms: Average Transaction Sizes
Mean Transaction Size
- OurCrowd & SyndicateRoom have net-worth/income requirements for investors (similar to many “Accredited Platforms” in the U.S.)
- Rankings should not be viewed as performance indicators. Many other variables are at play.
- Numbers are self-reported — some platforms may include funds raised offline in the aggregate amount.
As you can see, even with regulatory variability, there’s surprisingly—or perhaps unsurprisingly—little variance in transaction sizes. OurCrowd and SyndicateRoom, each with net worth / income requirements, and are more akin to online venture capital firms, are exceptions. Even still, we can safely put them in the early-stage bucket.
But what about later-stage markets: how will they move online? $5M, $10M transactions—are they possible? My belief: yes, but with an asterisk.
Servicing later-stage capital needs will require platforms to look and behave quite differently than what we’re familiar with today. Size begets complexity—and beyond some point of complexity, marketplaces will necessitate intermediation. The question is: how (and where) to intermediate?
While the proverbial “Crowd”—a distributed group of diverse individuals—is exceptionally well-suited to assess certain early-stage risks, product demand for instance, it’s not equipped to recognize and score the very different, and significantly more complex, risks that introduce themselves in later-stage transactions. The Crowd can be exceptionally wise; but it can also be exceptionally irrational.
The role of later-stage platforms, therefore, will not be to completely disintermediate. Rather, to intelligently intermediate: harness the strengths of the “Crowd” while supplementing its weaknesses.
How can platforms provide this intelligent intermediation, and move later-stage transactions online? I see three ways. #1 & #2 are more or less tools, and being used in various capacities today. #3 isn’t as much a tool, but a marketplace that will move intermediaries online, out of the shadows, and into more open, transparent and issuer-friendly environments.
3. Intermediary Marketplaces / Online Broker-Dealer Networks
1. Online + Offline
Let’s imagine that Potapia, the “Chipotle for Baked Potatoes”, is raising $5M on PlatformX. It’s likely someone will have to lead with a $500k+ check, and that someone (be it an individual or fund) is going to want face-to-face time with management. Conference calls, webcasts and online investor forums are great tools, but they can only take a deal so far.
Enter the Online+Offline transaction.
A few platforms, OurCrowd and CircleUp for example, have tested the offline waters. So far the format has been fairly plain vanilla: an investor breakfast here, a luncheon there. But this is just the tip of the iceberg. We’re not talking the traditional banking “roadshow”, a dreadfully inefficient, expensive and distracting process that all too often sends key management on a cross-country road trip with very little (if any) insight into where real investor interest is. (Which wouldn’t be cost-feasible on a $5M raise anyhow.)
Naw. With key informational advantages over traditional intermediaries, Platforms can do much better.
They intimately know (a) their investors; and (b) their intent on any given transaction. Instead of flying blind and guesstimating the when & where of real investor interest—and sending management on a road-trip to find out—Platforms can tactically plan events based on investor behavior captured on-platform.
It’s the best of both worlds: interest can be marketed to, captured and measured online. Then converted offline. Just think of how many thousands of wasted meeting hours can be saved. As for Potapia: at least if the team has to go to Chicago in January, they know its meetings will be with serious (and informed) investors :-).
Seriously… Crowd-Tranches? I know, I’m with ya, the term annoys me as well. But it’s descriptive, and the best I could come up with for now. And hey, it could be worse: “Crowd-Cars” was first to mind ;-).
Anyhow, Crowd-Tranches are portions of larger transactions that Platforms carve out and offer to their investors. This structure is widely used today, particularly in the U.S. A few examples:
1. FundersClub single-company investment opportunities are tranches of larger rounds. For instance, FundersClub members may collectively account for for $250,000 of a company’s $5M Series A.
2. Each of RealtyMogul‘s investment opportunities are tranches of larger transactions. (Common on real estate platforms.)
3. SeedInvest is currently raising its $3M Series A on its platform. It raised $2M offline from traditional Angel & VC, and then opened a remaining $1M tranche to its members. (It blew by the $1M target and is now in overfunding.)
4. Junction Investments, a platform for film investing, lists tranches of film deals that are already fully funded by traditional capital. (Films go into production with or without Junction investors participation.)
You can see how the Crowd-Tranche model could be used to bring larger and more sophisticated transactions online. Of course, it is a bit of hack given it’s not the whole transaction but only a piece of it.
As I see it, there are two key ingredients to making the Crowd-Tranche model work:
1. A “Lead” with deep domain experience and expertise;
2. A clear and outsized value proposition to the Lead, or the Issuer, for including individuals—e.g. funding flexibility, funding timeliness, funding repeatability, PR, marketing, customer acquisition, etc. (Otherwise, why open it up to the Crowd at all?)
I can also see the Crowd-Tranche model being used as a vehicle to bring the Crowd into follow-on rounds. (Which is especially important in VC where the distribution of returns are notoriously fat-tailed; investors need to ride the winners they get.) Microventures, for instance, could compete to invest in larger-follow-on rounds on behalf of its investors. (If they have sufficient influence in the earlier rounds, they may even be able to negotiate a pseudo tag-along provision that guarantees its members the opportunity to invest a predetermined amount in follow-on rounds. Unsure if this is being done by platforms today.)
3. Broker-Dealer Networks
Returning to Offerboard, it’s important to note that it’s not designed to kill intermediation, but rather, re-define, and optimize it. It recognizes the importance of connecting issuers with the right advisors who can efficiently and effectively guide issuers through large, complex transactions. There are other companies that have plans (or may have plans) to move later-stage markets online as well.
- AcePortal Notably, NYSE acquired a minority stake in ACE last year. It’s not transactional today, but they could add a transactional layer in the future.
- Axial Markets Axial has not, to my knowledge, indicated plans to open a marketplace, but they have all the pieces for it. Speculation on my end.
- ConfidentCrowd Led by the founder of Dinan & Co, a large middle-market investment bank, CC announced its intention to created a connected network of broker-dealers last year. It’s currently updating its platform and plans to relaunch this Summer.
- Nasdaq Private Market NPM is focused on secondary transactions today, but it has disclosed plans to move into primary issuances.
- PitchBook Pitchbook’s business today is research and data, but it unveiled a new section on its site last Fall called Marketplace. A “free, online marketplace that connects sellers and buyers in the private equity and venture capital industries.”
Offerboard is the first, to my knowledge, to open a fully transactional later-stage marketplace. It’s early, but I’m excited to see how they, along with others, make raising later-stage capital suck less. Just how bad can it be today?
Well let’s say you’re an issuer raising $15M. Your CFO asks around for advisor recommendations and proceeds to meet with a handful of boutique investment banks.
- They all have “proprietary” relationships;
- They all show league-tables that put them at the top of their (conveniently) self-defined category;
- They all give references to past successful transactions;
- No one gives a straight answer on fees;
- It takes 4 weeks and myriad overpriced lunches to meet with everyone;
- You’re still uncertain of who is the most qualified advisor.
Hugely time consuming. Fee structures aren’t transparent. And the information asymmetry, both pre and intra-transaction, disadvantages the issuer. Even after you hire the advisor (hopefully you hired the most qualified one), there’s little in the way of monitoring / measuring their performance. Inefficiencies and redundant costs plague this antiquated process, and it’s screaming to be improved.
As it moves online, I suspect, surely hope, it will be.
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