Venture Capital: The Walled Garden of Finance
As a basketball fan, I’m comfortable knowing I can never become the next Shaquille O’Neal. That’s fine. No amount of weightlifting can transform me into a 7-foot, 325-pound juggernaut.
But when it comes to making money, I do everything in my power to imitate the big guy. He’s an investing whiz. Not only did he make timely bets on Apple Inc. (NASDAQ:AAPL), Five Guys Enterprises LLC, 24 Hour Fitness, and more, but he invested in Google—now Alphabet Inc (NASDAQ:GOOGL)—before the IPO.
That said, there’s only so far I can follow. Shaq, like many of his celebrity kin, gets special access to premium investments that you and I do not. They get an unfair advantage.
For example, here’s Shaq’s explanation of how the Google investment came about. (Source: “Shaq’s Babysitting Gig Led to His Google Riches,” The Ellen Show, June 11, 2018.)
“I’m actually babysitting the guy’s kids while he’s in a meeting,” O’Neal says. “So after the meeting, he says, ‘You know what? You’re good with kids, I like you, I’m going to bring you in on this investment. And it was called Google. He said, ‘You know, in the future, you’re going to be able to type on your phone, search engine this, do this, boom, boom, boom, you should invest.’”
Are you kidding me?
What are the odds of that happening to you or me? Or, for that matter, to anyone who’s not living in the Hollywood Hills? Close to zero, I’m guessing.
Another example is Bono, the lead singer of U2, whose investment firm wrangled a 2.3% stake in Facebook, Inc. (NASDAQ:FB) pre-IPO. (Source: “Bono’s group has made more money from Facebook investment than from all his music,” The Independent, September 1, 2015.)
At the time, Bono’s firm paid roughly $86.0 million. Now that stake would be worth approximately $13.04 billion, an increase of 15,063%.
Retail investors don’t get these opportunities. However, the barriers keeping them from private equity and venture capital are slowly eroding, thanks in large part to Title III of the JOBS Act.
Enacted in May 2016, Title III gave retail investors a side-door into these walled gardens. Which means that you, me, and every other individual investor out there can be at least a little more like Shaq.
We too can invest in the next Google.
Note: Although retail investors have greater access to startups, there are still limits to observe with regards to income and net worth. Here’s a chart to help you keep track of how much you’re allowed to invest.
|Investor Annual Income||Investor Net Worth||Calculation||Investment Limit|
|$30,000||$105,000||Greater of $2,200 or five percent of $30,000 ($1,500)||$2,200|
|$150,000||$80,000||Greater of $2,200 or five percent of $80,000 ($4,000)||$4,000|
|$150,000||$107,000||10% of $107,000 ($10,700)||$10,700|
|$200,000||$900,000||10% of $200,000 ($20,000)||$20,000|
|$1,200,000||$2,000,000||10% of $1,200,000 ($120,000), subject to $107,000 cap||$107,000|
(Source: “Section 2.b. – Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers,” U.S. Securities and Exchange Commission, last accessed June 26, 2018.)
Equity Crowdfunding, ICOs, and BDCs
Now that we’ve got that out of the way, let’s get into the specifics.
There are three ways you can dip your toes in the venture capital pond: Equity crowdfunding, initial coin offerings (ICOs), and publicly-traded business development companies (BDCs).
Using a range of web sites, from Angellist to Crowdfunder, investors can buy small a piece of startups. This was considered a promising avenue a few years ago. However, in the years since it was invented, very few startups have chosen it over traditional venture capital.
My guess is that a lot of them find it embarrassing, as if taking money from regular investors is somehow less dignified than groveling to billionaire VCs.
CircleUp CEO Ryan Caldbeck has a different explanation. In a 2016 guest column for TechCrunch, he predicted that “No one will be talking about crowdfunding in five years.” (Source: “Equity crowdfunding is dead,” TechCrunch, May 16, 2016.)
“I say this knowing that advocates and policymakers will widely celebrate the launch of equity crowdfunding when new rules open up that permit equity investing for all Americans, not just the wealthy. These rules come four years after the JOBS Act, and finally complete the promise of the regulation celebrated by so many. Unfortunately, because of the way the law is designed, and because of the way the industry is heading, “crowdfunding” won’t matter.”
Whatever the reason, you’re unlikely to find positive value through equity crowdfunding.
Initial Coin Offerings
By now, most people know that Bitcoin isn’t the only cryptocurrency in the world. There are nearly 1,600 alternatives, and most of them came about through an initial coin offering, or ICO.
These ICOs are similar to stock initial public offerings (IPOs), in the sense that companies ask for money to finance their operations. However, key differences exist between the two groups.
For one thing, stocks only become public when they’re fairly mature. Cryptocurrencies, on the other hand, can emerge with nothing more than a web site and whitepaper.
Secondly, tokens don’t necessarily give you an equity stake in anything. Some are just digital currencies. The rest are essentially store credit for their respective companies. You can redeem them for services in the future.
However, if the firm’s product goes viral, the value of tokens could skyrocket, meaning that you are (in a way) betting on the company’s future.
Business Development Companies
Publicly traded BDCs are another way into private markets. What sets this angle apart, though, is its simplicity and safety. You don’t need to visit vague web sites or dabble in murky asset classes—you just buy them like you’d buy stocks.
That’s because BDCs are listed on regular stock exchanges. You give them money, they invest in startups. Which means they are, at base level, closed-end investment funds available to one and all.
Below are some of the biggest BDCs trading in the U.S.:
- Apollo Investment Corp. (NASDAQ:AINV)
- Ares Capital Corporation (NASDAQ:ARCC)
- Blackrock Capital Investment Corp (NASDAQ:BKCC)
- FS Investment Corporation (NYSE:FSIC)
- Gladstone Investment Corporation (NASDAQ:GAIN)
- Golub Capital BDC Inc (NASDAQ:GBDC)
- Hercules Capital Inc (NASDAQ:HTGC)
- Horizon Technology Finance Corp (NASDAQ:HRZN)
- KCAP Financial Inc (NASDAQ:KCAP)
Oaktree Specialty Lending Corp (NASDAQ:OCSL)
Should You Invest in Startups?
As I said before, equity crowdfunding and ICOs are a little suspect.
You don’t really see top-tier startups willing to raise money from unaccredited investors, despite their insistence on the wisdom of crowds.
You also don’t know whether the SEC might suddenly tighten regulation of ICOs. No one knows whether they are securities, currencies, or commodities. The only explanations anyone offers up are stuffed with terms like “utility tokens” and “use-cases.”
So I wouldn’t recommend either avenue, as they involve either weak prospects or heightened uncertainty.
BDCs, on the other hand, offer a safer, more diversified approach to venture capital and private equity. Besides which, you can buy them from your existing brokerage account. So, if you’re looking for a way into private markets, this is probably the way to go.
The steepest inclines in asset values usually come in the early years, so I think gaining some exposure to venture capital is a smart thing to do. However, you should remember that with higher returns comes greater risk.