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Why The Angel List Syndicates aka Twitter Follower Model Could Change the VC Industry October 1, 2013

Posted by bernardlunn in Uncategorized.
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Angel List Syndicates allow angels who want to be VCs to establish a track record and that is a big deal.

A long time ago I had a friend who had a gopher job at Lloyds Insurance. He was a “runner”. He described how massively complex risk could be financed in a day. Imagine insuring a space rocket launch, how on earth do you figure out the risks? This was a real world example. Lloyds had lots of specialists, one of them was a space expert. He would set the rate, basically committing his investors to underwrite the risk. My friend would then walk/run around to all the other specialists who would only look at two things – the area of expertise and the expert. If those two lined up, the other specialists underwrote massive sums in an instant, just putting in an amount and signing their names. My friend and I were staggered by how much money was deployed in such a short time around hugely complex subjects. This was an incredibly efficient system (yes, Lloyds later blew up but that is a totally different story).

The same thing happens with Warren Buffet. A whole tribe of Buffet wannabees track him and try to follow his trades.

I call these the “super experts”, the specialists who really knows their subject cold, who have done their 10,000 hours and done well financially in those 10,000 hours. They are the same folks that journalists court as sources and that you can follow on Twitter.

The point is that this is also how new ventures are financed. Like the space launch example, each venture has massive complexity and risk, but once the lead investor signs on, others follow with their checkbooks open. The Internet destroyed my friend’s runner job. Now the other experts simply Follow each other.

The VC industry – it is now an industry – has worked by herding those experts into a few funds. The funds were the gates to those experts and they charged a hefty toll to all – LP investors and entrepreneurs – for the privilege of getting access to those experts.

The folks running those funds were smart enough to know that they were not the 10,000 hours experts in all those specialist areas, so they did two things:

1. They invited those 10,000 hours super experts to co-invest in deals in their domain. This was a great win/win: – Fund got the insights and network of the super expert.
– Super expert got to invest on same terms as the Fund without any fees.

2. VC Funds pitched a more general skill as investors and venture scaling experts. Most 10,000 hours super experts don’t want to lead a round. They don’t need to work that hard and are smart enough to know that they don’t know how to do all the things that a smart VC Fund does, like setting valuation.

The Angel List Syndicates is just using technology to make easier what smart investors are already doing. I recently attended a meeting of private investors who had made money as entrepreneurs and now wanted to invest well to maintain wealth for future generations and philanthropy. As each described what they did it became obvious that the best way to invest would be to follow in their tracks. For example, somebody who made their money in real eatate in Houston and had been doing it for decades. If he were to invite you into his deals, you would do well. If you had the same track record in another market its a simple quid pro quo deal.

To use Hedge Fund terminology, the domain expertise and network of the 10,000 hours super expert is “Alpha”. However somebody still needs to do the hard work around all the other stuff – negotiating terms and leading the Board. That is where Syndicates become an alternative to VCs.

The VC business is the most Darwinian power law. Both LPs and entrepreneurs know that the returns are massively skewed to a few elite firms. Taking a risk on a startup fund is too big for most LPs. This implies a “permanent aristocracy” of a few firms.

Angel List Syndicates allow angels who want to be VCs to establish a track record; that is why it is a big deal. It enables upstart investors to get their foot in the door.

Eliminating the 2% fee is a crack in the wall of fees. I expect competition on the 20% carry as well from investors wanting to establish their reputation.

Three cheers for the Angel List guys for the biggest change to the entrepreneurial ecosystem in ages.

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