Venture capital (VC) first became a mature asset class to fund early stage and growth stage startups in the 1970s. Since then, companies such as Apple, Microsoft, Google, and Uber have brought significant returns to investors. Some entrepreneurs may argue that “VC-backed” is one of the constituents for successful startups. Today, there are about 1,000 active venture funds in the United States.
But VC is not accessible for everyday investors. And for many decades, there was no way for them to invest in startups. However, the landscape of venture funding changed when online startup investing launched in 2016. Equity funding platforms such as Fundable, FundersClub, Wefunder, and SeedInvest emerged in the public eye, creating the online private market. Today, there are 70 FINRA-approved funding platforms.
Both traditional VC and online startup investing provide ways for investors to access the high return potential offered by startups. But major differences exist in deal sourcing, diligence processes, term sheets, regulations, and reporting.
Deal sourcing is how venture funds initially screen investment opportunities. In a nutshell, traditional venture funds heavily rely on investors’ networks and “exclusivity.” Relationships with founders play key roles in obtaining quality deals. If there is no existing relationship between a founder and an investor, the investor can only hope for founders of quality deals to reach out with a cold email. Consequently, an emerging fund manager’s deal flow can be severely handicapped by the fund’s reputation — or lack thereof. Many large-cap funds, or funds that invest a greater portion of their assets into companies with large market values, heavily invest in marketing and creating events in the hopes of attracting quality companies. But this can negatively impact a fund’s operational expenses. Therefore, deal sourcing can be inefficient and expensive for traditional venture funds.
For online startup investing, all deals are fully transparent and discoverable on funding platforms. All investors are on the same playing field when sourcing and screening companies. In addition, the real-time progress for each funding round is also shown to the public. This piece of information is crucial for many investors to source and secure the deal in time. In addition, the number of new deals has been growing significantly year over year, so there are now more opportunities than ever before. Through KingsCrowd, an independent data and analytics platform, both institutional investors and everyday investors can source deals by efficiently finding companies that match their investment thesis. KingsCrowd provides tools to filter by industry, valuation, security type, number of investors, momentum, and more.
Due diligence is the term for researching and vetting a startup to ensure that it is a favorable investment. Depending on a fund’s given investment strategy, the diligence process can potentially take months. After the initial deal sourcing, the diligence process typically starts by directly conversing with founders. If investors are interested in moving forward with the deal, founders will then disclose data, audited financials, organizational charts, etc. Some funds even directly shadow startups and monitor day-to-day operations. In general, this diligence process is best practiced when investing large checks in a limited number of startups. It does not scale well to making numerous small investments.
In contrast, the diligence process for online startup investing is fast paced with high volume. Founders disclose company information on the raise pages for their startups and through offering details required by the SEC. Investors typically do not have direct conversations with the founders beyond the Q&A or discussion sections of raise pages. As a supplement, KingsCrowd provides Founder Profiles, where research analysts interview founders and ask diligence questions. Furthermore, KingsCrowd also produces Analyst Reports — deep-dive analyses of startups and their investment deals. In addition, the KingsCrowd Startup Investing Podcast and Technori Podcast can offer investors insight into raising startups, industries, trends, and more. Combining raise pages, SEC offering details, and KingsCrowd, investors can conduct a thorough and comprehensive diligence process.
Term Sheet and Check Size
For traditional venture investing, investors and founders negotiate the term sheets on a case-by-case basis. VC investors will negotiate for favorable valuation, security type, term length, voting rights, and more. Because traditional venture funds invest with larger check sizes, they typically have some bargaining power. Larger funds are also reliable sources of follow-on rounds — the additional funding needed for startups to grow at scale. Smaller venture funds can negotiate and invite larger funds with great bargaining power to be lead investors in the same round. As a result, term sheets are often more favorable to funds. Founders will then benefit from the funds’ reputations, networks, and potential follow-on rounds.
For online startup investing, founders set the term sheet. The minimum check sizes often range from $100 to $1,000. Due to the smaller check sizes, there is typically no negotiation involved between investors and founders. Even though investors do not have much bargaining power on investment terms, founders often create “early bird” incentives that offer discounts on valuation.
Regulation and Reporting
For traditional VC investing, companies can only accept money from accredited investors, and there’s no limit to how much those investors can give. Depending on the operational involvement of the venture funds, companies typically report to investors quarterly. Large-cap funds that own a substantial share of a company may also obtain a board seat with voting rights. However, private companies are not required to disclose financial information to the SEC or the public.
In online startup investing, most startup raises fall under Regulation Crowdfunding (Reg CF) and Regulation A (Reg A), which both accredited and non-accredited investors can participate in. Reg CF limits companies’ maximum raise amount to $5 million every 12 months, and Reg A limits maximum raise amounts to $75 million every 12 months. For companies raising under Reg A, audited financials of the previous two years and ongoing financials must be disclosed to the SEC and the public. Startups using Reg CF also have financial reporting requirements that aren’t found in VC investing.
KingsCrowd Capital Fund I
The KingsCrowd Capital Fund I captures the advantages of both traditional VC and online startup investing. KingsCrowd Capital will utilize KingsCrowd’s advanced data analytics to source and filter the best quality deals and initiate conversations with founders to conduct deeper diligence. While founders set the term sheet in online startup investing, KingsCrowd Capital can still negotiate on a one-on-one basis and give our investors terms that favor them more. Startups and their founders can also benefit from marketing support and potential follow-on rounds. Furthermore, the KingsCrowd portfolio management tool will only make reporting to KingsCrowd Capital’s investors easier.