This is one of the first guest posts I’ve had in a long time, potentially years. It’s by Taylor Davidson, who is my colleague at kbs+p Ventures. It originally appeared yesterday in his premium newsletter entitled, “From Me to You.” I highly recommend that you subscribe to it, if you are interested in startups, finance, and digital media.
I got Taylor’s permission to take his post outside of his paywall ($4/mo) to put live here. It is on a topic that we spend time thinking about: Index Funds of Startups. Enjoy the post and leave comments as always.
[From me to you] 74 – Investing in Startup Index Funds
“The thing people don’t realize about SecondMarket, it’s not about fucking Facebook and Twitter stock.” (link)
Every so often I get an email from SharesPost updating me on news and implied valuations of the most active companies on SharesPost’s secondary market for private company stock. And every time I look at their venture-backed index …
… I wish I could buy shares of the index without having to place individual bets on the companies composing the index. Why?
Darren and I talk often about our investment philosophy and why we focus on specific areas within that philosophy. A topic that often comes up is the difficulty in picking winners in crowded spaces with undifferentiated companies, even if the area is growing and drawing significant spend and investment dollars. We often say “I love the space, and if I could invest in an index in the space, I would, but because it’s very difficult for us to pick a winner in the space, we don’t invest in that space.”
Accredited investors can directly invest in private companies and buy traded shares of private companies on secondary markets, but there are very few ways for accredited investors to make index investments in venture-backed companies. *
One way is to simply invest in a ton of deals with minimal oversight and a filtering system that focuses on a particular stage, area, or type of investment opportunity. In my mind, the closest we have to “venture index funds” today are:
- 500 Startups: perhaps the most intelligent “index fund” of startups, investing $25K to $50K (approximately) in companies that need design, data and distribution to make a breakthrough. Dave McClure and Paul Singh invest early in a ton of companies, and then double-down (participate in follow-on funding) in the most promising companies. In essence, their focus on stage and the company’s big need is what creates their “index”.
- Start Fund: A joint venture between Yuri Milner and SV Angel (Ron Conway), the Start Fund gives $150K convertible notes to every company that makes it into Y Combinator. In essence, getting into Y Combinator is the filter and the base of the “index” that the Start Fund is investing into.
- TechStars: TechStars recently announced they will offer every accepted company a $100K convertible note, in addition to their standard $18K for 6% equity investment. Getting into TechStars is the filter and the base of the index that TechStar’s investors are betting on. Not quite the same as the first two, but close.
But few investors can create the structure and the access to deal flow to create their own index. That’s why SecondMarket and SharesPost have the opportunity to create indicies of the overall venture-backed market, and then build separate indicies of different areas of venture-backed companies: adtech, greentech, edtech, govtech, socialtech, ecommerce, phototech, entertainmenttech, B2B, B2C, European, Latin American, etc. Accredited investors could then invest in indicies in certain areas of venture-backed private companies, supplementing their direct investments with their indirect index investments in areas where they may not be able to a) pick winners directly or b) get direct access to startup investment opportunities.
Granted, these secondary markets are still relatively immature and may not yet have the volume or liquidity to support any index funds, but it’s the type of evolvement that we are bound to see in the secondary markets as they mature and grow.
And there are some industries and hot areas of venture-backed startups where I would love to be able to place index bets.
* A topic first discussed in letter #27, I’ll buy shares in a SecondMarket index fund. Who will be the first to create one?