August 18, 2017 | Webinar

Is the VC Party Over? What The Slowdown in Early Stage Funding Means Five Years Out

Rohit Kulkarni 00:08

Okay. We are going to go ahead and get started. Happy Friday, and good morning everyone on the West Coast, and good afternoon for everyone who is joining us from the East Coast. On behalf of everyone here at SharesPost, I would like to welcome you all to today’s webinar. I am Rohit Kulkarni. I’m the managing director of the private research group and SharesPost. Among other things, I oversee our website’s content, data, and research group. I am very, very excited to have with us David Rose, who is the co-founder and CEO of Gust. Gust is a global SaaS platform for incorporating and operating early-stage companies, and then sourcing and managing investments that fund them. I’ll let David do most of the talking here. I came across him during my research work, recently, on trends in fintech and private company fundraising, and I thought his insights would be very helpful for anyone looking to do more work in this space. David’s resume and accomplishments are long and very impressive. He has been described by Forbes as the father of angel investing in New York. He is a New York Times bestselling author, a serial entrepreneur, super angel investor, and the list goes on and on. So I’m very excited to pick his brains today on a very relevant topic, what is exactly happening in private company fundraising, in particular, angel seed and early-stage funding? And as a marketplace with predominantly late-stage investors on SharesPost, I thought there would be some leading indicators that we could glean off of David’s insights. So before we jump into the main part of this webinar, for anyone who is joining us for the first time, Sharespost is a financial services forum bringing together shareholders, and individual, and institutional investors to create liquidity within the private tech growth asset class.

Rohit 02:05

We have been in business for six-plus years, and this is just a sample of the companies we have transacted in. I work in a group called SharesPost Research, launched in late Q3 last year, and these are all the reports that we have published so far. In particular, starting earlier this year, we started what we call is company specific deep-dive reports. UBER, Airbnb, Pinterest were the ones that we have worked on so far, and many to come. We conduct webinars like these with experts such as David and many other people and have received good feedback from investors and issuers alike. All the information is available and stored for investors on our website, so these are the links below. You just need to log on to your account. We continue to talk a lot about what’s happening in the market, be it IPOs, be it specific sector trends. Again, all these things are on our website. Before I jump over to David, a couple of quick things I would like to highlight, again, on a broader macro standpoint what is happening in private tech funding since the end of the great recession, if you will. Over the last six and half years, the number of $100 million rounds, which we call as private IPOs, have somewhat inflected which has sort of had a direct impact on number of real IPOs you have seen. Also, this slide to me is very important because this is what it tells us what is going to happen over the next five years. A lot of money sits on the sidelines on the balance sheets of private tech investors. The dry powder, which is money waiting to be invested continues to rise. In fact, yesterday I saw a very detailed report from Financial Times Preqin that the amount of dry powder that venture capital and private equity investors is at a 20-year high, inflation adjusted. So that’s something that tells you about the shape of things to come.

Rohit 04:23

So another key question we keep getting is, what about unicorns? We understand a lot of companies are getting outsize valuations over the last three, four, five years. What happens over the next 3, 4, 5, 6 to 10 years? If you join the prior to charge with the shape of things to come, we remain fairly positive that a lot of technological trends are to some extent coming together along with capital sitting on the sidelines. So private tech growth as an asset class would continue to grow in size and scale. Last month, a quick plugin is about what we call as the private tech growth index. Again, we think it is a unique resource exercise where we combine a lot of data points around all the valuation signals around private tech companies, particularly the late, late-stage ones. This is available on our website. We have a micro website where we have a lot of details, and we will be updating it on a quarterly basis. The simple take-away here is over the last two and a half years, the private tech growth index has outperformed the broader market indices. But if you zoom in over the last six quarters or so, it has underperformed. So the broader kind of takeaway for us is the recent modest performance of private growth companies may create an attractive entry point for people looking to harvest over the next two to three years. Again, I believe I took a lot more than I wanted to. But with that I wanted to bring on David, who’s the main speaker. David, it’s all yours now.

David Rose 06:11

Great. Hi, everybody. My name is David S. Rose, as Rohit mentioned. A little background on me so you know from where I come. I am an early-stage guy, about as early stage as you can get. I’m a serial entrepreneur. I’ve started half a dozen companies, my first when I was 10 years old and all the way through school and after school. I’ve turned into an angel investor well over a decade-- about 15, 20 years ago. I have invested, personally, in over 120 companies at the earliest stages. As an active angel investor, I founded New York Angels, which is one of the top 10 angel groups in the United States, probably in the world that is 120 accredited investors in New York investing in a wide variety of typically tech-related deals. On the side, I’m associate founder of Singularity University, which is the post-graduate think tank in Silicon Valley, devoted to exponential technologies founded by Ray Kurzweil and Peter Diamandis that has spun out a bunch of really interesting, disruptive exponential growth startups. And as Rohit mentioned, I’ve written a number of New York Times bestselling books, particularly, Angel Investing: The Gust Guide to Making Money & Having Fun Investing In Startups, which has become the sort of standard textbook for how to be an angel investor, and has been translated into a bunch of different languages, and is now the textbook given out by most angel groups. But my day job is as founder and CEO of a company called Gust, G-U-S-T. Gust, based here in New York City, is the backend infrastructure platform for the world of early-stage entrepreneurial finance. And by early stage, people who are on SharesPost and people who invest in the public markets often are not aware of the total disconnect between how early early stage is. Early stage is very, very, very early, when you have an idea, at the innovation and the ideation stage. And so that’s what I-- when I start companies from scratch as an entrepreneur when I invest in them as an angel investor, it’s investing really early on.

David 08:23

And so, therefore, before we go into what’s happening with trends and how they may affect the rest of the later-stage world, let’s get a fundamental definition out of the way, and that is, what is the difference between a VC, or a venture capitalist, and an angel investor? And the bottom line is that VCs are professional money managers. They are closer to the world of public companies and late-stage private equity. They raise a pool of money from limited partners, and they go and invest that money, and they get compensated for making that investment and high returns on that investment. In contrast, angel investors are individual people, idiosyncratic, one-off, individual people managing their own money. They’re what I describe as rich-ish people. Because if you’re really, really rich, you don’t have time to spend mucking around in the swamp of the early stage, pure seed startup world because it’s very messy, and there are a lot of them. And the amounts of money you invest at the earliest stages are very, very small, that don’t even compare at all to the large, later-stage rounds that you’re doing. So this is what the funding looks like in the early-stage industry. So if you take a look at all the various sources of capital, or players, from the left to the right, you’re talking about as the company chronologically goes through its stages from an idea to a business plan, prototype, betas, product. It’s actually got sales and revenue and then it’s profitable. And obviously, as you move from an idea to profitability, the risk decreases. But also, as a company grows from tiny to larger, the amount of money that’s required on the vertical axis goes up. This is, by the way, a logarithmic scale, so that’s 10x between each of those numbers there. And because risk and reward are interrelated, the less risk there is and the more money is invested, typically, the lower the returns are for that.

David 10:15

But the interesting takeaway from this particular chart, which came from Tom Stephenson and Verge - it’s a great picture here - is that the public markets only come into play in that little yellow box in the upper right-hand corner. All the stuff that’s happening before that is before a company gets on the radar screen of the public markets. And there’s a lot of stuff that happens early on, much, much lower numbers. All kinds of things that are not even considered in the later stage. In particular, if you look at what happens and how companies are founded, every year in the United States there are something on the order of two to three million new-business-taxes returns filed for the first time. And of those, most of those, the majority are single practitioners, one person doing business as a dog walker, a landscape gardener, or something. But there are about six or seven hundred thousand employer businesses that are incorporated, hire employees, pay payroll taxes, and so on and so forth. And of those employer businesses, six or seven hundred thousand of them, the large majority are funded by the founders themselves. They don’t take in any outside capital. And for those that do take in outside capital, the vast majority of that comes from friends and family, the informal economy, which is an-- I mean, billions, deca-billions of dollars a year passing outside anybody’s ability in tracking that. So then what you’re looking at, the angels there, typically, independent angel investors are investing anywhere from 55, 65, 75 thousand deals a year. Over the last 3 or 4 years, it’s ranged from 55 to 75 thousand deals that angel investors are investing. That’s 70,000 companies compared to the fact that you’ve got a grand total of 5,000 publicly traded equities in the United States today. So it’s an enormous number of stuff that’s happening off the radar, below anybody’s threshold.

David 12:08

And VC is funding early-stage deals, fewer than 1,000. This is very, very simple. Because if you look at the difference between angels and VCs at the early-stage funding, angels typically are funding stuff at the very first ideation stage, the first beta testing, get product market fit, minimum viable product. And VCs, the large majority of VCs, well, from the public market perspective, here’s “Oh, these are really early-stage things.” From my perspective, speaking as an angel investor and an entrepreneur of the startup things, these are all later-stage deals. These are all companies have got revenues, extensive revenues and maybe profitability and the like. And because the difference is so large and so fundamental, in terms of the kinds of things that angels invest in versus the kind of things that VCs and professional investors invest in-- let me show you how the economics work from the perspective of an angel, and I think it might be eye-opening. So let’s take a-- not a typical angel investor who may have a-- they’re accredited investors, which means they passed the SEC qualification of having at least a million in investable assets, not including their primary residence, or $200,000 in income. So let’s say you’re not a typical angel investor has $10 million dollars to invest, totally. So because angel investing is really, really, risky, they’ll take a million of that, less than 10%, and invest that in startups. But because these startups are so risky, individually, themselves you want to diversify that as best you can. I suggest that typically, you should be investing, if you’re serious about angel investing, in anywhere from 20, 30, 40 companies. But that can be a really big commitment. So instead of that, let’s say that this theoretical angel will only invest in 10 companies, which is about the average of what angels actually do. So you’re distributing that $1 million across 10 companies. Now, what kind of return are angels looking for? Well, as you know, the public markets are 5% hedge funds, maybe 10 private equity, maybe 15, the top venture funds will target 20% returns, so if you can’t beat those, why are you in angel investing at all?

David 14:10

So let’s say it turns out that the average return, over a long period of time, for a professionally-managed angel portfolio is about 25% IRR. And so the typical VC investment period is a five years or so, as Rohit mentioned in the-- you have, what, 66 months from founding to IPO for the unicorns. And so angels invest earlier than VCs, so let’s tack on another year and let’s say six years, right? So in an ideal world, you’d be getting a 25% IRR over 6 years. And so what that means, if you look at that in terms of ROI, return on investment, you’ve got to do 25% for 6 years, which means that you put in a dollar at day one, at the end of year 6, you have to get back 3 dollars and 80 cents for 3.8 times return on your investment. And so that would be really nice if you could get it. So how does that work? But the interesting thing is the difference between investing in public companies or later-stage companies and investing in the really early seed-stage stuff, is exactly how risky it is. Because of those 10 deals that our typical angel will invest in, history has shown, again, and again, and again, that 5 of those deals are going to crash and burn totally, taking 100% of the invested capital in there. So if you tell a public market investor that they’re going to lose 100% of their investment in half the companies they invest in, they’d go running for the hills because that’s not the way that business works. But that is the way the angel world works. But luckily you’ve got five other companies in here, right? So of those remaining five that aren’t total write-offs, what we see over time is that roughly two of them will return the money you put in. Because it’s an asset sale, or an acquihire of a team, or somebody buys the IP, or the furniture, or whatever after six years. But, luckily you have three that turn a profit. And of those three that turn a profit, two of them are going to be nice, solid hits. You’re to get three times the money that you invested back after 6 years. Okay?

David 16:03

So that’s not too bad if you can get it happening all the time. The only problem is, each of these companies only accounts for one tenth of your portfolio. So what that means when you do the math is if you add up all the returns you’ve now gotten from all of those companies, from 9 out of your 10 companies, you get the 0 plus 0.2 plus 0.6. And if you take that away from your 3.8 that’s your target to try and get, the result is a hole in your targeted return of 3 times your entire original investment. And so based on that kind of crazy economics, which is the economics of seed and early-stage investors, when you do the math, if you have to fill that 3-0 hole from only one company who represented one tenth of your portfolio, the only way the math works is if that last one deal returns 30 times the original investment. And therein lie the secret economics of the angels, which is that we are targeting insanely high returns. Because 9 out of 10 of them aren’t going to hit it. And we don’t know which one is going to hit it. So, therefore, every deal that angels look at has to target a 30x or thereabouts kind of return. So with that as the basic understanding, let’s also take a look at what we can learn from leading indicators from these angel deals. I said I run this platform, Gust. So Gust is the infrastructure platform that high-growth entrepreneurs use to actually found, incorporate, operate, and manage their companies. And then, [inaudible] support on the other end, over 75,000 investors, we were the official platform for the national federations of angel investors in 28 countries and continents. And so we have lots of entrepreneurs coming on every month, every day, onto Gust, creating profiles for their companies and reaching out to investors. And we did a survey about six months ago, and here were the demographics that we found, which I find fascinating because they are not at all like what you see in the public markets. If you take a look at the public market CEOs, or the CEOs of private equity-backed companies, or even the ones that get venture-backed, who are more diverse than the later-stage companies, it doesn’t look anything like that. 41% of the entrepreneurs who are coming onto our platform are female. 32% are minority. This is the future of innovation that’s happening here. So if you want to look at leading indicators, you’re going to have a much, much more diverse world over here.

David 18:31

In terms of the kind of companies that angels invest in, this is the data taken from the Angel Resource Institute. It’s the research arm of the Angel Capital Association. They’re a Halo report. And this shows the valuations for the different industries. And so, typically, the ones that are the most amenable to angel financing are companies that are enabled by technology. They are typically online business products and services, computer hardware and services, consumer products and services, and then increasingly things like health care, Internet, mobile software and the like. So these are the things that are starting out getting-- remember, angle funding only counts for a tiny percent. Angels only invest in about 2.5% of opportunities they see. So 97.5% of startups are not being invested by angels. So the 2.5% that are, this is the breakdown of the industries that you’re looking at. And now, let’s take a look at how many deals are being done and, typically, what the typical investment is. And this is where things get to be really interesting. And the title of this webinar was How Does the Slowdown In Early-Stage Things Affect the Later Stage? Well, it turns out that the slowdown, once you delve into the numbers, is very interesting. Looking at the lefthand side there, this is data from a PitchBook from the National Venture Capital Association. You see that the typical median size for a seed or angel deal has been about $500,000, steady for the last several years, the earliest stages. But seed, whatever you define as seed, has been skyrocketing, almost on a hockey stick, and is now up to a million and a half. Now, what does this mean? It means that a lot of the nomenclature has been changing, and it means that the economics of the early-stage world have been changing in a way that is almost completely divorced from the public markets. We’re seeing now the ability to start a company very, very, very inexpensively. There is so much available in cloud-based services, and open source, and tools and connectivity that the economics of company formation are completely different. Our own platform, Gust, has something called Gust Launch. So if you’re a high-profile entrepreneur, you can come on to Gust Launch and click a button and for, literally, $99 a month be up and running with an incorporated company, with everything from $15,000 in Amazon Web Services to an hour a month of legal, to all your incorporation, your registered agent, your backend equity and financial stuff. Everything is done for $99 a month. With companies being able to start that inexpensively, taking advantage of all the stuff that’s out there, there is less and less need for early-stage, seed-stage financing to get a company off the ground. So here, again, taking some data from PitchBook and NVCA, you’ll see--

Rohit 21:15

Hey, David. This is Rohit. Sorry to interrupt. On that previous chart about angel and seed, so can you kind of draw that out even a little bit more? As in, if it is getting so inexpensive to start a company, scale it up, why is there this hockey stick, in terms of the amount of capital being invested by seed investors? As in, is it getting harder to scale those companies from seed to Series A or is it getting-- or is it a way that seed investors believe that they are going to get outsize returns and hence outsize investments are needed. Again, I’m--

David 21:57

Right. It’s actually almost the inverse of that, really. What you’re seeing here is because companies can start so inexpensively, they can get a lot farther down the road without a big infusion of cash, right? And so they can-- so what you’re seeing, not exactly but pretty close to it, is that now companies have managed to start with an idea, get the minimum viable product market fit, get their first customers, go international, get all the stuff happening, and now they are ready to have the gasoline poured on for high growth. And so therefore, the first seed round is not because they need that money to get started, it’s because they need that money to grow. So what you’ve affectively seen is a shifting of all of that growth capital world way earlier into the process of starting a company. So now, you look at the flatline that was going there up to 2013, companies don’t need all of that traditional VC money to get started. You can now get that money from an accelerator, from your friends and family, do it yourself. You can get it from a business competition. You can get it from-- you don’t even need it. You can get free stuff from a lot of vendors who will help you get started because once-- if you [inaudible] out to be the kind of thing to be, if not a unicorn at least a gazelle, of a high-growth company, you will be able to then grow really quickly, and that’s where that additional cash is coming in. So unlike historically, where the seed money would’ve been used to help a company get going, now it’s used to help a company grow. And that’s why on the right-hand side of that chart, you see that the amount of money going in at these early stages for, later, bigger amounts of money. This is all growth as we define growth in the earlier stage, not growth capital now in the venture world. But this is all to take a company that has found product market fit that it is virally growing and help it get bigger and bigger.

Rohit 23:48

Interesting.

David 23:50

Okay? So, therefore, now go to this one and take a look. And so, by the way, when you say angel and seed activity, historically, 20 years-- when I started investing, if you had said angel and seed stuff is-- what is that? And that would be, “Oh, those VCs and those crazy people investing $10 in a guy around the corner.” Well now, this is what you’re looking at here in these numbers, and these are the only ones we know about. This doesn’t include the founder funding. This doesn’t include the accelerator funding. This doesn’t include friends and family funding over here. So while the number is going down, what you’re looking at these are the numbers that we are realistically tracking angels who report these things, angel groups, larger angel rounds, early stage venture micro VC funds over here. So this is not-- this seems to show that money coming into startups is decreasing, when in reality that’s not what’s happening at all. Yes, it’s decreasing but it’s all a question of how you define startup and how you define money and how you define who’s coming in. So while this looks like it’s going down, it’s instructed to see what happens after this. Right? So this is early stage VC which comes in after startups. And here you can see it going up. The last four quarters, you’ve been increasing not decreasing. And then if you go even later down-- this early stage VC. If you take a look at the later stage VC, it’s skyrocketing even more. So what this is meaning is the number of yields and the amount of money going into our venture funds is not going down, it’s going up. And that’s because the quality of the deals that they are investing in is going up. And that’s because you’ve got more and more companies that are starting and manage to get a lot further down the road from the financing that does not come from this official financing world. It’s coming from the unofficial financing world.

David 25:38

And then when you go even beyond that and you take a look at follow-on rounds by VCs, these follow-on rounds, that’s not pressure on the market, you take a look they’ve held steady. There are fewer down rounds than there have been in the past. Most of these rounds are up routes. You’re seeing companies, better companies, that are being funded later in the founding process by these funds. So before we start taking questions from the crowd, let me run through of few of the really interesting things that are getting a lot of press now in this space and that actually do have some indications of where things are going in the later stage in public markets. Right? So one of the trends that have started, literally, in the last 5 or 10 years is the existence of online funding platforms. So originally, you had companies like Gust. We were one of the very, very first that connects early-stage entrepreneurs and angel groups. And we are a tools platform. Right? But once the JOBS Act of 2012 was signed, it provided for the ability to have actual funding to be done on an online platform. And so Title II of the JOBS Act allows you to create a portal where accredited investors only people within net worths over a million or income of over 200,000 can find and actually transact an investment into an early stage company. And then Title III of the JOBS Act which only finally went into effect in May of 2016, having been put into law in 2012 with the JOBS Act allows non-accredited investors, the average anybody, to invest in the early stage companies. There was a thought that this would engender an enormous explosion in funding as you open up the floodgates to regular people. In reality it didn’t work that way, because in reality there are a lot of restrictions on what you can do and what companies, by the way, should be invested in. But you are now seeing the crowd beginning to settle and there are title III funding platforms like SeedInvest and Wefunder and StartEngine that are actually now beginning to do millions of dollars every month in funding early-stage companies. Title II platforms, these are ones like AngelList and CircleUp and the like, and SeedInvest also, these are platforms that allow accredited investors. And they are doing significant rounds. In some cases, up into the double-digit millions, funding platforms. So these are an alternative now to traditional angel rounds or venture rounds. Then, of course, there’s AngelList, which--

Rohit 28:16

Hey, David, quick question. So is it a reasonable hypothesis to have that over the last couple years, some of the slowdown in industry reported numbers that VC and seed early stage may not take into account what’s happening on the online funding platforms?

David 28:38

I don’t think they’re-- yes, I think they’re not actually tracking the online stuff. But again, the numbers coming out of the online platforms are not sufficient to move the needle, right? What I think that is not being tracked is the informal stuff, the very small deals, the individual angel investments, the stuff done on a convertible note, or estate, or something that is not reaching the filing requirements and is not being done by a broker-dealer. Many of the organized groups and certainly all of the platforms end up reporting something to somebody. So I think most of those are being picked up. But what you’re not seeing is because it requires so little money to get a company started, that’s the stuff that’s not being reported. If I’m an entrepreneur and I can put in 10, 20, 50,000 bucks of my own money to get started, that’s not showing up on anybody’s scale until I turn around and get a 2 million-dollar seed round or something. Right? So what’s happening here is not a slowdown, I believe, per se. Although there are always slight troughs and bubbles and it is a little bit cyclical, but there’s no enormous, going over a cliff here. What you’re seeing is a challenge in the industry now for research, and tracking, and definitions. What is angel, what is seed, what is pre-seed? That term didn’t exist 10 years ago. What is early venture, late venture, what’s micro venture, super angel? These terms are so fluid, they are literally changing on, almost, a month-to-month basis, which makes it very, very difficult to track this kind of stuff. And there are fundamental changes in the way the industry is operated. So, for example, with angel syndicates, you’re now seeing-- so AngelList led this where their goal is to disintermediate venture capital funds. So they’re trying to get rid of these CDs and have the LDs who would be limited partners who would invest in those funds and back, directly, one angel investor, a super angel, who has put their money into an early-stage startup. And then people are backing that individual investor on an individual company rather than a fund investing over a long period of time.

David 30:40

Another major, major change is the rise of accelerators. So these started out-- the first accelerator was Y Combinator, founded by Paul Graham, in Cambridge and Silicon Valley. It’s now the most famous of the early-stage accelerators. But there are a number of other major networks out there from 500 Startups to Techstars to Dreamit to a bunch of others. There are now, literally, thousands of accelerator programs around the world. And their goal is to take early, early-stage teams with an idea and over an intensive period of three months or so, help them through mentoring and through providing software and tools and services and peer support, help them find their product-market fit. And then at the end of that three-month period, come out with seed funding and potentially raise venture funding. So you’re seeing tons of companies. And on Gust, right now, we support something like 900 accelerator programs and their entire application and judging processes. And so on Gust, we are bringing on 12,000 companies every single month onto our network. And these are companies that are applying to accelerators, and angel groups, and the like. That’s one hell of a lot of companies out there, right? And so these accelerator programs will typically take a cohort of anywhere from 10 to 40 companies coming in, provide them with very basic seed financing. Y Combinator started out providing $3,000 per month per founder. So for a typical $15,000 stipend to help them cover their expenses while they were in the program. And then at the end of the program, there’s a demo day where these companies, now spiffed up, are presented to early-stage investors and seed funds. And you’re seeing a lot of this early-stage venture money going into companies coming out of accelerators.

David 32:30

Another major trend here is that of corporate venture investing. Because the world is changing so fast, this is event of the whole singularity approach to exponential development. What you’re looking at here is a world in which it might rely on that one, is any company that was designed for success in the 20th century is doomed to failure in the 21st, because the world is changing so rapidly. So if you are an existing public company, or a large private company, you have to innovate or die. There is no option. You will be hosed. Lightning doesn’t often strike twice in the same place, and so whatever your business was that let you be successful, you now, effectively, whoever you are, have to reinvent it, do it all over again. And you can try and do it internally, but it sure makes a lot of sense to look outside, to look at these innovative, young companies and to see if they can help jumpstart your innovation process, or acquire, whether it’s something like Avis acquiring Zipcar, is a great example. Or any of these other larger companies acquiring new startups to help jumpstart their innovation. That’s really important. So you’ve seen a real rise in corporate venture investing. Virtually, every major company now has some type of corporate development, corporate venture arm where they’re constantly looking at either investing in partnerships with early-stage companies or turning around and actually acquiring them in as the centerpiece of their future stuff.

David 33:58

And then, one of the sexiest things, currently, that’s on everybody’s lips these days, is the concept of an ICO, initial coin offering. This came out of the whole blockchain world, which came out of the whole bitcoin world. And the idea here, people -- nobody might know, in the financing market, what it means. But essentially, what’s happening here is that for companies that are involved in these so-called crypto-currencies, and doing things in the space whether it’s bitcoin, or Ethereum, or the like. They are raising money, completely not part of any kind SEC round or anything else, any equity round. But they are selling future tokens for their services. And because this is a part of the bleeding edge of where really far-thinking entrepreneurs are doing, people who have a lot of faith in the future, there have been some recent ICOs, insane amounts of money, literally tens of millions of dollars. Now, for most people who are serious observers of the scene, this is a bubble to end all bubbles. It makes no sense. It’s an enormous thing. It’s all based on blind faith. This stuff is going to skyrocket and be worth a fortune in the future. In terms of being a there there?, there’s actually, today, relatively little there there in these ICOs that are generating these enormous numbers. However, the fact that there is no there there today belies the fact that this is going to be critically important in the future. Not ICOs, per se, because the SEC pointed out in a ruling a couple of weeks ago that they are going to be subject to the same regulations as IPOs, real markets, and stuff. And so they’re not getting anywhere close to there. So I wouldn’t worry about that in any kind of significant impact on anything.

David 35:41

However, what they are pointing to is with the blockchain, which is a fundamental technology-- the blockchain is the technology that underlies fintech. And this is going to, without question, be a major, major sea change in certainly all kinds of technologies, and particularly the financial technology in the world. So every major fintech company in the world today has got a blockchain initiative going on somewhere. The banks are doing it. The exchange is creating platforms. Everybody is doing it. How this will, actually, ultimately affect the market remains to be seen. And which companies will succeed and stuff, is a bubble-- so which companies will succeed and which will fail, also remains to be seen. So ICOs, as they are today, are irrelevant and I would effectively ignore them. ICOs as they are as a pointer for things that are happening in the future, the direction things are going to take, are critically important. And that means you should begin to understand what’s going on. And then the final thing, if you want a little bit of dramatic foreshadowing, that I will suggest and then we can take questions, is something that has not yet hit anybody’s radar, but I will tell you, it’s coming down the road, and that is the question of algorithmic seed investing. Because if you go back and look at what I’ve been saying for the last several minutes, about how there are more and more of these seed-stage companies, these idea companies that are starting out. Entrepreneurs are around the world, of all kinds, requiring much less in the way of capital to get going. But there are many more of them. And yet at the public investing and public-impinged investing world of private equity and these later-stage VC and so on and so forth, they’re still doing the same number of deals from a much larger base of potential opportunities. The question is then going to be is there a way to sort of figure out and to solve for that enormous thing. If Gust, our own platform, today is doing 12,000 companies a month, that’s 150,000 companies a year coming out at the other end, right? So how on earth can you possibly look at 150,000 companies to figure out what you should invest in? The answer is no one person can. It’s going to have to be done technologically.

David 37:45

And so in this world that we’re seeing, where companies are increasingly starting online-- remember with Gust Launch at $99 a month. Not only do you get everything incorporated and is it all done effectively as a [inaudible] way it should be done. But because it’s all being done online or in the cloud, everything is instrumented. Every part of your cap table, every part of your accounts, every part of your analytics, and your advertising, and your revenue is all being done. And you’re going to see this increasingly over the next few years, to the point where I believe that if you look at where the future is going, you’re going to have thousands of companies started by all kinds of people all over the world, which will be done mil-spec perfect, verifiable, auditable from day one, with all the metrics there that will begin to allow for expert systems, and all kinds of algorithmic funds, and thesis-based investing, where you don’t have to go in and talk to the individual company. You can make a thesis bed on Internet of Things, or blockchain, or people coming out of Carnegie Mellon, or whatever the heck you want to do, you will be able to do that at scale. And that is how, I think, you’re going to be able to take this enormous mass of companies that are currently starting and bring them into the later-stage world of public equities. And so with that, I will take a deep breath, and I’m happy to respond to questions.

Rohit 39:02

Okay. That was super, a lot of things to digest, David. One quick clarification, would you highlight anybody that’s doing or is in the process of launching the last thing on your slide, the algorithmic seed investing?

David 39:16

As Steve Jobs would say, “I can not comment on announced products.” But suffice to say, the only way that works today is-- you can’t do algorithmic investing unless you have the data to base your algorithms on, right? And so right now, today, there is no way to get 100% of a company’s data unless they were to give it to you. And it’s all different, and all non-standard, and so there’s nobody doing that now. On the other hand the closest to that is a company called Right Side Capital Management, which raised a small venture fund and is having entrepreneurs fill out exhaustive questionnaires and details to try and figure out how many patents they have and this and that and so on. And they have a good idea, but they’re trying to do it in the context of gathering data from companies that exist, which is challenging. What we’re doing with Gust Launch, by creating companies digitally from day one-- with Gust Launch, a company starts out, we incorporate them in Delaware. We are their registered agent. We write [inaudible] corporation. We write their option plan. We manage their backend, their accounting, bookkeeping and everything else. Which means that you have, for the first time, on platforms like this-- and right now, I think we’re the only one, but I wouldn’t be surprised to see others come into play. You have an entirely instrumented company from the get-go and totally instrumented and standardized. And so you apply that against the 12,000 companies a month who are creating profiles on Gust-- and I think it’s not going to be long, a year or two, three, five - pick a number - before you have the ability to do real algorithmic seed-stage investing.

Rohit 40:45

Okay. Interesting. I guess, we have a few questions, but I’ll just choose a couple of them. On ICOs, as in-- there are a lot of comparisons between what’s happening in ICOs over the last, probably, six months as compared to-- pick a day or a quarter in late ’90s. Where do you think we are as far as ICOs are concerned? Are we in the beginning of ’98, beginning of ’99? Or where are we, as far as baseball innings are concerned?

David 41:19

I’m going to go out on a limb here - and it’s a public forum, so I’m going to be quoted on it - but I mean, ICOs are ridiculous. I mean, I don’t mean to demean anybody in doing this. And there clearly people who are putting big money on ICOs, but I know of nobody-- or the view of anybody in the serious financial world who looks at this with anything other than some type of either bemusement or amazement because they don’t make a whole lot of sense. They make sense for a teeny, weeny, itsy, bitsy type of company doing a teeny, weeny, itsy, bitsy type of thing in the blockchain space. But because a couple of companies raised an enormous amount of money from people who just want to be in the next big thing, everybody is now taking this seriously as if it’s a major play. And it’s not. So with that being said, that’s ICOs per se. But ICOs as an indicator of where things, and how things, are going to happen on the blockchain with public scale kinds of investments, that’s absolutely going to happen. But that’s a number of years off, and it’s not going to be based on ICOs. And I think that, frankly, any time that a serious investor would spend looking at ICOs today is not well spent.

Rohit 42:34

Okay, okay. I just want to be careful of time. One last question. It’s been asked a couple different ways on our Q&A forum here. There seems to be a growing notion of people as in the value chain of private investing seems to be shifting right. By that, what I mean is, angel investors seems to be cutting larger check sizes. Seed investors are cutting larger check sizes. And that’s flowing through the ecosystem as the companies progress. And late-stage, pre-IPO private tech investors are now cutting even more bigger checks sizes. They’re squishing company’s plans to go public. And by what I seem to be hearing from you today that that notion seems to continue to persist and probably in an even greater manner from what we are seeing in the early stage today. As in, what do you want to add to that? Or what--?

David 43:33

Absolutely. What you are seeing-- so there a several factors that are driving this, and the biggest factor is technology. When I first started my very first venture-backed company, I raised-- my first series A in 1991 from Warburg Pincus. That company took 20 million bucks in venture capital to get to our Internet product shipment, because the Internet was just starting at that point. My second venture-backed company took only two million in venture capital to get to Internet product shipment. My first company as an angel investor took only $200,000 to get the Internet product shipped. We did a deal with the New York Angels about seven or eight years ago called Palm V, which was an online video stock footage marketplace. When they came to us, the founding team had a full founding team, full management team, they had created their own website. They were up and operating, generating revenue, while total cash they had put into play was $20,000. Today, if you have an idea for some kind of online mobile app or something, you can sketch it out on the back of a napkin, shoot it with your iPhone, send it out into the ether where somebody in the Czech Republic is going to quote 2,000 bucks, put it in the app store, and start getting revenue. So to go from a world in which it takes 20 million dollars in institutional capital to get a company started and to a world where, today, you and your backyard or whatever, and your toilet seat, for 2,000 bucks get a company going, that has changed the very fundamentals of what’s happening. And that has shifted everybody upscale. So as angels started, they now can invest in later and later stages, and VC and micro VCs and later and later, and private equity later and later. So everybody is going upscale, which is why at the early stages, the only way that the very, very earliest, earliest ideation stuff is going to work is as we just discussed with things like algorithmic seed investing or stuff that’s scale in the blockchain world and the like.

Rohit 45:32

Okay. Super. I think, probably, we should wrap it up. I want to be super careful of your time, David. We are a couple of minutes over. But again, I would thank you very much for your time today. I know we have a few unanswered questions here, and I will forward them to you, David. But again, this was extremely insightful. My contact information is on the screen. And many of you have requested access to the webinar presentation. We will be sending follow-up email with a link to the presentation, and we will have slides and video online. Again, thanks again, David, and any last comments?

David 46:17

No. We live in very exciting times, and if there’s one word from The Graduate, Dustin Hoffman’s character was told the word is plastics. I would say the word today is exponentials. You have to think exponentially, because exponential technology is changing every single industry and every facet of every industry. And that’s why any company that was [inaudible] enough to [inaudible] will die in the next one unless you innovate. And this is a great time to be investing in these early stages. But the time a company remains early stage is shrinking. You’re going from zero to 70 billion in seven years. So it’s a fascinating time to be in.

Rohit 46:50

Super. So the VC party continues. Thank you very much for joining us today. Hope everyone has a good weekend ahead.

David 46:57

My pleasure.

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This report is being published by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management, LLC., an investment adviser registered with the Securities and Exchange Commission, are wholly owned subsidiaries of SharesPost, Inc. SP Investments Management, LLC is the investment manager of the SharesPost 100 Fund, a Registered Investment Company, and other funds. These entities and funds (hereafter “SharesPost”) does, seeks to do business with, owns and/or seeks to own positions in the companies covered in this research report. Consequently, investors should be aware that SharesPost has a conflict of interest that could affect the objectivity of this report. This report was originally prepared and distributed to institutional and certain private clients of SharesPost Financial Corporation. Recipients who are not market professional or clients of SharesPost Financial Corporation should seek the advice of their own personal financial advisors before making any investment decisions based on this report. None of the information contained in this report represents an offer to buy or sell or a solicitation of an offer to buy or sell any security and no buy or sell recommendation should be implied, nor shall there be any sale of these securities in any state or governmental jurisdiction in which said offer, solicitation or sale would be unlawful under the securities laws of any such jurisdiction.

This report does not constitute an offer to provide investment advice or service. Registered representatives of SharesPost Financial Corporation, do not (1) advise any member on the merits or advisability of a particular investment or transaction, or (2) assist in the determination of fair value of any security or investment, or (3) provide legal, tax or transactional advisory services. Information regarding companies in the SharesPost 100 List available on the website has been collected from or generated from publicly available sources. The availability of company information does not indicate that such company has endorsed, supports or otherwise participates with SharesPost. Company “thesis” are the opinions of SharesPost and are not recommendations to buy, sell or hold any security of such company. Investors should be aware that the SharesPost 100 Fund (the “Fund”) may or may not have an ownership interest any of the issuers that are discussed in the report at any given point in time. Accordingly, investors should not rely on the content of this report when deciding whether to buy, hold, or sell interests in the Fund. Instead, investors are encouraged to do their own independent research. Before investing in the Fund, Investors are cautioned to consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus with this and other information about the Fund, please visit www.sharespost100fund.com. Read the prospectus carefully before investing.

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The analyst(s) certifies that the views expressed in this report accurately reflect the personal views of such analyst(s) about any and all of the subject securities or issuers and that no part of such analyst(s) compensation was, is, or will be, directly or indirectly, related to the specific views contained in this report. Analyst compensation is based upon various factors, including the overall performance of SharesPost, Inc. and its subsidiaries, and the performance and productivity of such analyst including feedback from clients of SharesPost Financial Corporation and other stakeholders in our ecosystem, the quality of such analyst’s research and the analyst’s contribution to the grown and development of our overall research effort. Analyst compensation is derived from all revenue sources of SharesPost, Inc., including brokerage sales.

DISCLAIMER:

This report does not contain a complete analysis of every material fact regarding any issuer, industry or security. The opinions expressed in this report reflect our judgment at this date and are subject to change. The information contained in this report has been obtained from sources we consider to be reliable, however, we cannot guarantee the accuracy of all such information. Any securities offered are offered by SharesPost Financial Corporation. SharesPost Financial Corporation and SP Investments Management, LLC are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions. Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative and involves a high degree of risk and should only be considered a long-term investment.

You must be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and you should complete your own independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or other investment advice. Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment. SharesPost, the SharesPost logo, My SharesPost, SharesPost Index, SharesPost Investment Management, SharesPost 100 Fund, and SharesPost 100 List are all registered trademarks of SharesPost, Inc. All other trademarks are the property of their respective owners.

Contact

For information on research and analysis

Rohit Kulkarni
Managing Director
Private Investment Research Group
(650) 300-5128
Email
CONFLICTS:

This report is being published by SharesPost Financial Corporation, member FINRA/SIPC. SharesPost Financial Corporation and SP Investments Management, LLC., an investment adviser registered with the Securities and Exchange Commission, are wholly owned subsidiaries of SharesPost, Inc. SP Investments Management, LLC is the investment manager of the SharesPost 100 Fund, a Registered Investment Company, and other funds. These entities and funds (hereafter “SharesPost”) does, seeks to do business with, owns and/or seeks to own positions in the companies covered in this research report. Consequently, investors should be aware that SharesPost has a conflict of interest that could affect the objectivity of this report. This report was originally prepared and distributed to institutional and certain private clients of SharesPost Financial Corporation. Recipients who are not market professional or clients of SharesPost Financial Corporation should seek the advice of their own personal financial advisors before making any investment decisions based on this report. None of the information contained in this report represents an offer to buy or sell or a solicitation of an offer to buy or sell any security and no buy or sell recommendation should be implied, nor shall there be any sale of these securities in any state or governmental jurisdiction in which said offer, solicitation or sale would be unlawful under the securities laws of any such jurisdiction.

This report does not constitute an offer to provide investment advice or service. Registered representatives of SharesPost Financial Corporation, do not (1) advise any member on the merits or advisability of a particular investment or transaction, or (2) assist in the determination of fair value of any security or investment, or (3) provide legal, tax or transactional advisory services. Information regarding companies in the SharesPost 100 List available on the website has been collected from or generated from publicly available sources. The availability of company information does not indicate that such company has endorsed, supports or otherwise participates with SharesPost. Company “thesis” are the opinions of SharesPost and are not recommendations to buy, sell or hold any security of such company. Investors should be aware that the SharesPost 100 Fund (the “Fund”) may or may not have an ownership interest any of the issuers that are discussed in the report at any given point in time. Accordingly, investors should not rely on the content of this report when deciding whether to buy, hold, or sell interests in the Fund. Instead, investors are encouraged to do their own independent research. Before investing in the Fund, Investors are cautioned to consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus with this and other information about the Fund, please visit www.sharespost100fund.com. Read the prospectus carefully before investing.

ANALYST CERTIFICATION:

The analyst(s) certifies that the views expressed in this report accurately reflect the personal views of such analyst(s) about any and all of the subject securities or issuers and that no part of such analyst(s) compensation was, is, or will be, directly or indirectly, related to the specific views contained in this report. Analyst compensation is based upon various factors, including the overall performance of SharesPost, Inc. and its subsidiaries, and the performance and productivity of such analyst including feedback from clients of SharesPost Financial Corporation and other stakeholders in our ecosystem, the quality of such analyst’s research and the analyst’s contribution to the grown and development of our overall research effort. Analyst compensation is derived from all revenue sources of SharesPost, Inc., including brokerage sales.

DISCLAIMER:

This report does not contain a complete analysis of every material fact regarding any issuer, industry or security. The opinions expressed in this report reflect our judgment at this date and are subject to change. The information contained in this report has been obtained from sources we consider to be reliable, however, we cannot guarantee the accuracy of all such information. Any securities offered are offered by SharesPost Financial Corporation. SharesPost Financial Corporation and SP Investments Management, LLC are wholly owned subsidiaries of SharesPost, Inc. Certain affiliates of these entities may act as principals in such transactions. Investing in private company securities is not suitable for all investors. An investment in private company securities is highly speculative and involves a high degree of risk and should only be considered a long-term investment.

You must be prepared to withstand a total loss of your investment. Private company securities are also highly illiquid and there is no guarantee that a market will develop for such securities. Each investment also carries its own specific risks and you should complete your own independent due diligence regarding the investment, including obtaining additional information about the company, opinions, financial projections and legal or other investment advice. Accordingly, investing in private company securities is appropriate only for those investors who can tolerate a high degree of risk and do not require a liquid investment. SharesPost, the SharesPost logo, My SharesPost, SharesPost Index, SharesPost Investment Management, SharesPost 100 Fund, and SharesPost 100 List are all registered trademarks of SharesPost, Inc. All other trademarks are the property of their respective owners.