SPiCE VC: A VC Fund Powered by Blockchain
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We recently talked about how SPACs promised to “democratize” access to the world’s most exciting startups. That didn’t come to fruition because the stakeholders were incented to find a company and merge with it as quickly as possible. The SPAC managers would realize an immediate windfall, the VCs would see an exit, the company would receive a truckload of easy cash, and Joe Retail Investor was handed a bag to hold.
Investing in a company before it goes public provides exposure that’s not correlated to the movements of the broader stock market. Venture capital as an alternative asset class provides portfolio diversification which reduces risk. ARK Invest’s Cathie Wood recently talked about how innovation performs well during recessions, and there’s evidence to back that up. A white paper by Invesco talks about how venture capital (VC) has exhibited low to moderate correlations with other asset classes and a negative correlation to large-cap equities.
The diversification effect is accompanied by superior returns. The same paper shows how the top quartile of VC managers across any time horizon outperformed other major asset classes.
There’s a third reason to invest in venture capital firms. It’s exciting, and you never know which diamonds will be found in the rough, something that appeals to people’s psychological attraction towards uncertain rewards. Even the portfolio’s failures can teach us something, but most retail investors won’t have the chance to learn those lessons.
Investing in a VC Fund
Participating in a VC fund isn’t an option for most retail investors because they lack the net worth and/or connections to participate in a fund. Platforms like Forge and EquityZen allow you to invest in popular startups pre-IPO, but the minimums are prohibitive. Most investors don’t have the net worth needed to do so safely.
For example, let’s say you want to invest 6% of your assets under management in alternative assets. You choose three categories – wine, art, and VC funding – and allocate 2% of your assets to each. Ideally, you want a decent number of startups for diversification. One out of ten startups will fail, so you’ll want to hold at least ten. With $10,000 minimum to participate, that means you’ll need $100,000 for your VC fund allocation, which means you’ll need at least five million dollars in assets under management. The average net worth of American families is $748,800, so a 2% allocation would be more like $15,000. Platforms such as Securitize provide another option.
Securitize and SPiCE VC
In our past piece on Securitize: A Complete Platform for Securitization we talked about the first venture capital firm that digitized their portfolio and put it on the blockchain – SPiCE VC. That fund is now traded on the Securitize platform and we’re going to take a closer look at it today, starting with the notion of “net asset value” or NAV.
A VC fund starts out with a pile of cash they raise from limited partners (LPs) which is used to invest in startups over time. If a VC raises $50 million in cash, that sits in a bank account waiting for investment opportunities to arise. The NAV is $50 million. When an investment is made, the NAV is then calculated by adding together the value of the remaining cash and the present value of each startup investment.
Stocks are valued based on whatever price they’re trading at. Private companies are valued based on whatever valuation they last took funding at. If you pay $100 for 10% of Little Johnny’s lemonade stand, then it’s implied that his business is worth $1,000. Subsequent funding rounds are usually at a higher valuation, otherwise they’re called “down rounds.” Typically, the NAV for a VC fund will rise over time as portfolio investments gain value. That’s precisely what’s happened with the SPiCE VC fund which started out trading at $1.00 per share NAV and is now valued at $3.21 a share.
Most publicly traded venture capital firms trade at a discount to their NAV which – studies suggest – is because not much information is made available about privately held companies and there’s minimal liquidity. You can buy shares of SPiCE VC for $1.95 right now which means you’re getting an almost 40% discount. Seems like a bargain, but this is where you need to consider liquidity – what you can sell those shares for immediately upon purchasing them – $1.01.
When you have a bid-ask spread that wide, you don’t engage in trading. Those who choose to go long SPiCE VC are best served holding their shares until the fund is liquidated. That’s a good segue into talking about what the fund holds.
SPiCE VC Fund I
As time goes on, the winners will start to emerge in any given VC portfolio and command a greater percentage of the NAV. SPiCE VC started investing in 2018 and targeted a 7.5-year time horizon for the fund – 3.5 years of new investments, 2 years of follow-up investments, and 2 years of portfolio management. They’re at the later stages of that plan which means the cream has risen to the top. Below you can see the breakdown of holdings with the largest being the platform that makes it all possible – Securitize.
The above chart doesn’t show the three exits the fund had last year which would have benefited investors as all the money gets paid back as exits happen. It’s a great way to learn about how VC investing works and investors would be best served holding their shares tokens until the fund has been liquidated to maximize value.
Over the years, we’ve been searching for ways to get exposure to startups without having to try and cherry-pick winners ourselves, or plunk down massive amounts of cash to get proper diversification. There are other ways to invest in startups, but they don’t offer the simplicity we see with Securitize.
Other Ways to Invest in Startups
We’ve covered publicly traded venture capital firms extensively and never found them compelling. Sure, we do like some U.K. funds like Molten Ventures (formerly Draper Esprit) and Scottish Mortgage Investment Trust, but ask yourself this. Just how much additional overhead gets eaten up by these firms because they’re publicly traded? Think about all the rules and regulations they need to adhere to or incur penalties by regulators. This results in a lot of unnecessary information. Ideally, we want to invest in a fund that keeps communication very simple. Here’s what we want to know on a quarterly basis:
- Has net asset value increased or decreased?
- What notable milestones or accomplishments have been made by portfolio startups?
- Has any startup gone pear-shaped?
There’s a difference between investing in a fund that’s properly managed versus a collection of startups. EquityZen offers a fund that consists of 15 to 25 startups which they select from the many being traded on their platform. “Commitments in an amount equal to at least $75,000 will be strongly considered for acceptance,” says the firm, and again we see a minimum amount required that puts this out of reach for most retail investors. Not only that, but we want a portfolio that’s managed by tenured venture capitalists who know when to exit a firm because the writing is on the wall. We believe that management of a portfolio is worth the fees paid to the managers. Invesco warns that those promising returns will only happen with access to premier managers and careful portfolio construction. It’s just one of many reasons why people who participate in equity crowdfunding are taking on huge risks.
Equity crowdfunding has become hugely popular, and we’ve warned investors to stay away from it like the plague, mainly because shares of private companies are worthless unless you have the ability to liquidate them. Most equity crowdfunding platforms peddle companies that aren’t incented to exit. There’s a reason these firms chose to crowdfund their operations as opposed to landing proper VC funding. Whenever you see a firm that raises VC money and then moves to a crowdfunding platform, that’s generally the kiss of death. For crowdfunding to be viable, there needs to be a secondary market.
Securitize now offers a secondary market that allows investors to buy and sell tokens that represent equity in companies or fractional ownership of a fund. You don’t necessarily need blockchain to do that, but it certainly makes record-keeping a whole lot easier. Smart contracts that execute between vetted accounts mean the entire process can be automated and easily traced. This removes the need for high transaction fees and allows firms to drop minimum investment amounts to something more accessible for the average retail investor.
Our Take on SPiCE VC
We live and breathe startups, so we’re particularly attracted to the simplicity of SPiCE VC. The quarterly reports they produce are concise and easy to digest. It’s actually fun to watch the evolution of their fund and you learn something along the way. The fact Securitize is their most successful investment thus far is a good thing because intuitively there’s a lot of money to be made by unlocking all the illiquid asset classes out there like venture capital or private equity. That said, the fund first began investing in 2018 with a seven-year time horizon. We’re coming across it late in the fund’s lifecycle which explains why several startups command the lion’s share of the portfolio’s net asset value. We’d also like to see more liquidity on the secondary market, something that will probably come with time.
Should Securitize begin offering other venture capital funds on their platform (SPiCE VC just raised a $250 million fund) then perhaps we’d be interested in dabbling a bit. Around 9% of our NAV is currently allocated to alternative assets – wine, art, bitcoin, and gold – so we wouldn’t be opposed to swapping the gold position out for something a bit more relative to what we cover here at Nanalyze.
Conclusion
Blockchain started out as a solution looking for a problem. Finally, the promise of securitization is showing some green shoots. If Securitize can make it easy and seamless for VC firms to raise additional capital from retail investors, it’s likely that funds like SPiCE VC could become the norm, not the exception. We’ll continue to watch this space closely because there’s strong evidence that having exposure to venture capital is a good compliment for equity portfolios like the two we’re currently managing.
Share
Unfortunately there is no way to invest in SPICE.
Regs only allow a certain number of shareholders on a per country basis.
See the error from securitize below.
“Cannot buy this asset at this moment because it has reached the maximum amount of holders in your country”
GUMI crypto is the Crypto VC fund that I found to be available to the public via the Japanese stock market.
We reached out to Securitize with a question on that. Thank you for bringing this up! Any firm that provides their investment collateral in Japanese is automatically off the radar. Lost in translation.
We can confirm that Spice VC does not have an international investor limit, so the message you saw may likely be in error or perhaps related to a different offering? If you continue to experience this issue, please email Securitize Support at [email protected] and they will be happy to help.