For many up-and-coming businesses, venture capital funding can make the difference between sustainable growth and shutting the doors. Venture capital is a critical resource for early-stage companies, while investors willing to take a chance on these businesses can potentially reap above-average returns. As the startup ecosystem continues to grow, venture capital investment surged to a record-breaking $131 billion in the U.S. last year, with 2019 off to a similar pace.
Despite the advantages of venture capital for both investors and issuing companies, however, access to these investments has historically been limited. Deals typically happen behind closed doors, excluding many investors from the process and limiting the number of people companies can raise capital from. Limited access and outdated transfer processes also make these investments highly illiquid, putting investors at a big disadvantage if they need to sell their stake.
But while inefficiency and inaccessibility have defined venture capital investing for decades, digitally formatted securities offer a new path forward. Digitizing venture capital allows investors from around the globe to access these assets while dramatically streamlining transfers, making it an efficient and effective fundraising tool for companies. Here’s how digitally formatted securities are changing the face of venture capital for both investors and issuers.
- Broader opportunities for investors and issuers. With digitization, investors no longer have to know the right people to get in on the next Google or Uber. Digitally formatted securities are available to qualified accredited, non-accredited and non-U.S. investors on a centralized platform, and lower investing minimums means new investors can afford these deals or spread their portfolio across multiple promising companies. Broader access also benefits issuing companies or funds by expanding the universe of potential investors, while secondary trading allows them to lock up capital without locking in investors. The possibility of increased liquidity also means investors will likely be willing to pay higher valuations, allowing companies to sidestep the typical “illiquidity discount” and raise more capital (or sell fewer shares).
- More transparency for investors. In the traditional venture capital markets, investors receive updates infrequently, at best, about the current value of their investments. Given that these investments are in emerging companies with limited operating history, that means investors are taking on significant risk with little insight into their potential returns. Secondary trading of these assets is also virtually non-existent, making it hard to gauge whether a position is performing as intended. Digitally formatted securities are bringing greater transparency to venture capital by giving investors visibility into market value. Based on where the asset is trading in secondary markets, investors can better understand their portfolio’s performance and make informed decisions about whether to buy or sell. For issuers, that transparency can help them establish a reputation for legitimacy, build stronger relationships with investors and ultimately aid in capital-raising.
- More timely payouts. Historically, venture capital investors have had to wait until the fund is dissolved to receive distributions from portfolio company sales, which can take up to a decade. Digitization allows for more efficient and timely distributions, with digital securities like BCAP and SPiCE having the opportunity to pay investors if a sale occurs in a timely manner. This feature is understandably attractive to investors, making it a potential differentiator for issuers as well.
A growing network
As venture capital funds and companies recognize the opportunities of digitization, a growing number of digitally formatted securities are entering the ecosystem. The venture capital assets currently trading on Openfinance include SPiCE, which invests in companies that build infrastructure for digitally formatted securities, and BCAP from Blockchain Capital, which invests in blockchain-based technology projects. These are excellent examples of private investment vehicles that have long been inaccessible to most investors.
Venture capital is critical for seeding and furthering innovation across our increasingly global economy. As digitization transforms this corner of the private securities market, both investors and issuers stand to benefit.