CHANGING CAPITAL: EMERGING TRENDS IN ENTREPRENEURIAL FinancE October 2016 ©2016 by the Ewing Marion Kauffman Foundation. All rights reserved. CHANGING CAPITAL: EMERGING TRENDS IN ENTREPRENEURIAL FINANCE Introduction products. Datasets and key industry publications were analyzed for venture capital (National Venture Capital Capital is obviously vital to entrepreneurs, and Association and Thomson Reuters), angel syndicate the sources and types of capital available to them investments (Angel Capital Association, Angel Resource are changing. The gaps that exist between investors Institute, Halo, and Pitchbook), angel investors (Center and entrepreneurs have narrowed due to networks for Venture Research), and crowdfunding (Equity created by new technologies. Easier communication crowdfunding portals, Crowdnetic, and Kickstarter). has created new ways for investors to aggregate and More information on methodology and the datasets deploy capital. Furthermore, the transaction costs of used can be made available upon request. capital formation are falling rapidly, as evidenced by the growth of phenomena such as crowdfunding, online Based on interviews and data collected, we angel syndicates, online lending, and new venture identified the following trends: funds operating beyond traditional hubs and with novel 1. The VC industry is shifting at the biggest and investing goals. smallest ends of the market. The Kauffman Foundation seeks to provide 2. Online platforms—for crowdfunding, angel improved data and analysis about trends in syndication, and lending—are increasingly entrepreneurial capital formation so that we can important options for seed-stage and early-stage encourage efforts to enhance the success rates of startup needs. entrepreneurs everywhere. This report examines 3. Sources of capital are emerging outside of current developments in the field, draws out some traditional geographical hubs. broad trends, and considers their implications for entrepreneurs. 4. Women are playing more decision-making roles in entrepreneurial capital. Data collection was carried out across several parts of the emerging capital landscape. Fourteen 5. There is robust experimentation with differentiated interviews were completed with experts across venture capital models. capital (VC), angel, crowdfunding, microfinance, and Following, we explore each of these trends based others involved with new financial technologies and on a review of data, analyses, and case stories. CHANGING CAPITAL: EMERGING TRENDS IN ENTREPRENEURIAL FINANCE 1 1. The VC industry in shifting at investing proportionally more in giant, late-round deals, thus allowing an increase in market share for newer the biggest and smallest ends funds committed more to seed-stage and early-stage of the market. investing. There has been a sizeable increase in the number Between 2013 and 2016 (thus far), the total of new small venture funds since 2010. Data from dollars invested in venture deals essentially doubled to Thomson Reuters show that, between 2010 and 2015, an annualized $60 billion, without an accompanying the number of new funds raising $100 million or has change in deal counts or first-time funding counts. This increased by a quarter, from eighty-eight to 119 (Fig. 1). change has instead been driven by investments in a These smaller funds tend to have one or two partners handful of outliers like Uber: exceptional, high-potential who often are entrepreneurs or investors with deep sector experience and often are re-investing money they companies that, instead of going public and further made from an earlier venture as a part of their funds. growing the business from IPO proceeds, elected to remain private and accept additional private funding. New funds, those that are three years old or Many of these later-stage “venture” rounds became younger, appear to be making smaller investments and quite large, in some cases reaching $1 billion or more. increasingly play a part in first rounds for the earliest- stage deals. Between 2010 and 2015, new funds As companies have chosen to stay private longer, increased as a proportion of total investments in first more money from outside the traditional VC industry rounds for seed-stage and early-stage deals, growing also has poured into venture deals. The recent rise of from 9.2 percent to 11.3 percent of the total (Fig. 2). corporate venture capital has been a primary driver of Venture capital industry insiders hypothesize that this trend. Data from the second quarter of 2016 show one possible reason for the surge in this type of new corporate groups deploying $1.2 billion in that quarter funds is a shift in the VC landscape: bigger funds are alone, participating in 20.6 percent of all venture deals.1 Figure 1 The number of small venture funds has increased in recent years U.S. venture funds raised for selected vintage years by fund size bracket (U.S. dollars) 2015 78 15 26 2010 58 15 15 0–30 Mil 30.1–50 Mil 50.1–100 Mil Kauffman Foundation Source: Thomson Reuters 1. PricewaterhouseCoopers et al. (2016). 2 CHANGING CAPITAL: EMERGING TRENDS IN ENTREPRENEURIAL FINANCE Figure 2 New funds are increasingly playing a part in first rounds for early-stage deals Venture firm age 3 years or younger as a proportion of all dollars invested in first funding rounds for seed and early-stage deals for selected years 11.3% 10.5% 9.2% 2010 2013 2015 Source: Thomson Reuters Kauffman Foundation Cross Culture Ventures | Cross Culture Ventures is an example of these new small funds. Founded by Troy Carter, who previously was Lady Gaga’s manager, the firm aims to invest $500,000 to $1 million at a time. It looks for “culturally driven” companies that will benefit from mainstream cultural trends. This strategy includes leveraging their insights into African American and Latino consumer markets to target niches that previously were overlooked. Typical Cross Culture investments include Thrive Market and Maven. Trevor Thomas, a general partner at the Cross Culture, describes Thrive Market as “Costco meets Whole Foods,” riding the “democratization of health and wellness” cultural trend. Maven, a company that makes artificial hair products for African American women, addresses the $9 billion U.S. hair weave market. This market has no e-commerce players and significant room to be more efficient. Cross Culture also offers expertise in business development, marketing, and public relations in order to differentiate the fund and give it an edge over super-angels or crowdfunding. This effort to be more innovative in order to get into the most competitive deals is typical in the VC industry today. Thomas reports: “It’s easier than ever to raise money, but harder than ever for funds to get into the best deals. You have to be able to offer something that’s really different to get into competitive deals.” Thomas describes a shift in the terms between investors and entrepreneurs. In 2010, after the financial crisis, term sheets were harsh. Between 2013 and 2015, they eased up as money poured into venture capital-backed companies. Now, Thomas explains, “there is some rationalization on valuations and a little bit sharper elbows on the funding and founder side.” There is more discussion of redemption rights and liquidation preferences to protect investments, but VCs are all being more innovative—offering access to networks, mentors, and customer relationships—in order to attract the best entrepreneurs. CHANGING CAPITAL: EMERGING TRENDS IN ENTREPRENEURIAL FINANCE 3 2. Online platforms— Angel syndication for crowdfunding, angel Angel investments reached over $20 billion in 2015,2 approaching the traditional size of venture syndication, and lending—are capital at $30 billion.3 In recent years, angel investing increasingly important options has become more sophisticated, with syndicates of for seed-stage and early-stage angels forming to take larger stakes in deals and build diversified investment portfolios. startup needs. The Angel Capital Association and Angel Resource Online platforms play an increasingly important Institute conducted a survey of angel groups, including part in the democratization of capital. The data show committed capital funds and networks, to better that increasing numbers of platforms and networks understand syndication and average investment sizes are making it easier for entrepreneurs to access in early-stage deals. They report that 46 percent of smaller amounts of capital, from either angel investors, angel groups surveyed invested $250,000 or less into crowdfunders, or online lenders. each deal (Fig. 3). Given that the median round size Figure 3 Many angel groups invest less than $250,000 in deals Average investment size of angel groups surveyed 46% 54% $250,000 or less More than $250,000 Kauffman Foundation Source: The Angel Capital Association and Angel Resource Institute conducted a survey of angel groups, including committed capital funds and networks, to better understand average investment sizes in early-stage deals. 2. Center for Venture Research (2015). 3. Massolution (2015). 4 CHANGING CAPITAL: EMERGING TRENDS IN ENTREPRENEURIAL FINANCE in 2015 was more than $800,000, a typical deal would require syndication and might need three or more groups AngelList | AngelList evolved out of a blog working together to close a round. Non- called VentureHacks in 2010. In six years, AngelList angel partners, such as venture funds, has gone from matching individual investors and private equity funds, and family offices, entrepreneurs to enabling the formation of angel co-invest more often in these larger syndicates, and now to managing purpose-built angel funds for both individual and institutional deals. capital. AngelList investors have invested $445 More sector-specific and geography- million in 1,040 startups since the company’s specific angel funds are emerging, inception.4 through which investors can bring more Kevin Laws, AngelList’s COO, explains that the expertise and connections to a deal. company’s broad and expanding social network Marianne Hudson of the Angel Capital serves the following key roles today: Association noted that she is seeing • A place for investors and companies to more platforms for angels and greater learn about each other.