Throughout my career, I've been involved both directly and indirectly in building capital networks: marketplaces that bring together investors and investment opportunities. Having recently left On Deck, I've taken some time to reflect on what I've learned. Note: the ideas I’m sharing below focus on private markets and alternative assets, but could apply to other areas of investment as well.
In the United States, private equity and credit have been instrumental in driving entrepreneurial growth. Capital networks have built some of our most powerful ecosystems. Silicon Valley itself is built upon a capital network flywheel: founder innovation leading to wealth creation, leading to re-investment.
Although private markets have historically lacked transparency and accessibility, recent innovations have opened up many new avenues for access. On the supply side, I’m optimistic that we'll continue to see the emergence of new investment structures, platforms, and services. On the demand side, we’re sure to also see continued desire for the potential alpha/beta afforded by alternative assets.
Start With A Supply Side Wedge
One of the main hurdles when launching any marketplace is: where to start? It’s the classic classic chicken vs. egg scenario: start on the supply side (investment opportunities), or the demand side (investors)? While there is not necessarily one correct answer, textbook marketplace strategy would typically start with the supply side. My experience has been the same: great investment opportunities will generate investor demand.
This was largely our approach at On Deck. We started by curating an incredible community of founders (ODF), offering them accountability, services (like co-founder search) and education. By assembling this valuable supply of founders, we naturally attracted interest from investors (and others) looking for access.
However, simply aggregating raw investment opportunities is not enough. Sophisticated investors have no shortage of investment options. In order to stand out, opportunities must be packaged and presented in a way that establishes trust/credibility and offers low transaction friction.
Example of opportunity packaging:
- Novel structure
- Novel structure could mean a new type of investment construct such as being able to invest in fractional artwork (Masterworks), aggregating fragmented supply/data (Opensea and NFTs), or offering an entirely new investable asset, like Alongside.
- Novel structure could also relate to a well know asset, but packaged for investment in a novel way. As an example, AngelList productizing SPVs opened the door for a new type of venture marketplace. More recent platforms like Allocate or UseTap use structural innovations to build new digital marketplace offerings for venture funds. iCapital, one of the OG capital networks, was a marketplace pioneer helping directly connect wealth management platforms (retail investors) with private market opportunities.
- Superior curation
- Curation can simply having a unique perspective. Many great funds and capital networks have launched and gained traction by focusing on a particular thesis or world view. Examples could range from a broad ESG focus to a fund like Union Square Ventures who publishes their (evolving) theses publicly.
- Education and/or ratings is also a common tactic. Many top alternative platforms like Moonfare offer extensive education on their asset classes through white papers, courses and more. Other platforms like Velvet, use third-party rating systems or credibility in the form of highlighting existing co-investors. Another form of education is often employed by smaller venture funds who employ LP education as value prop. These fund managers go out of their way to educate LP about investment decisions. Hustle Fund comes to mind here.
- FJ Labs talks about the future of marketplaces being “marketplace-pick” models. The idea here is that where eBay simply presents every opportunity and the customer must pick the right offering for them, in a marketplace-pick model, the marketplace itself picks the best opportunity for each customer (usually by leveraging 1 party data).
- Abstraction of complexity
- The true genius of AngelList was the abstraction of complexity surrounding angel investing (lawyers, taxes, etc). AngelList’s innovations were likely not possible without another market network, Y-Combinator, and its innovations of the SAFE.
- API-driven platforms like Sydecar and Brassica are also enabling platforms to watch
- Allocation exclusivity: funds & deal prioritization
- Many private market networks are inherently exclusive investors must be accredited, qualified purchasers, or HNWI to partake (example: Long Angle & Tiger21). However, even within these exclusive networks, prioritizing allocation can be a hot button topic. Unlike public markets, alternative deals tend to have limited allocations. When deals are particularly hot, everyone wants a piece. Capital Networks thus must be very intentional about how they structure prioritization so as not to alienate participants.
- One way to create platform exclusivity is the creation of platform funds. On Deck, AngelList and Fundrise are examples of platforms with dedicated funds creating a new source of platform value capture ($$ from management fees) as well as exclusivity. Funds can be marketed via a combination of attributes:
- Offering alpha: opinionated ‘cherry picking’ approach
- Offering beta: indexed approach
- Front running the best deals (FOMO)
- Leverage data and/or insights
- Other exclusive perks: Additional forms of exclusive access could be a GP providing SPV, or co-investment rights to LPs committing capital above a certain threshold.
As an example: AngelList formed Sax Capital (i.e., the Access Fund being AngelList’s index play) and has a partnership with a quant fund (their alpha play). In exchange for this superior access, AngelList charges minimum quarterly commitment for the Access Fund and a fund of funds model for the Quant Fund.
Market network is a term I first learned via NFX. The concept is to marry social networks with marketplaces. In a market network, buyers and sellers can interact with each other through a platform that provides tools and services to facilitate transactions and build relationships. Market networks can even go beyond social elements (like profiles) and offer more advanced SaaS workflows. As an example, NextGen Venture Partners offers tools and workflows for investors to collaborate on due diligence. AngelList offers workflows like portfolio tracking and allowing syndicate leads to search for additional investors from the PCN network. Another platform, Stonks recently launched a tax solution/workflow.
Offering market network features in advance of scaling the supply side can lead to superior user experiences and customer retention. These features also offer faster time-to-value, and offer benefits for investors independent of whether or not they actually transact.
Launching the Demand Side
Once the initial supply (i.e., the wedge) is secured and packaged, the focus becomes building demand. There are numerous strategies that can be deployed to attract investors, but it’s crucial early on to 1) attract the right early investors 2) do things that don’t scale’ 3) offer engagement beyond simply deal flow.
Finding the right investors means finding people uniquely interested in your investment offerings. There should be a clear alignment of interests investors should view the team/platform as credible. Ideal early capital network participants should also come with a working knowledge on the investments offerings. If early participants require lots of education upfront, things are in for a slow start.
Doing things that don’t scale could mean anything from hosting intimate events, to interviewing each new investor, or personalizing their onboarding experience (yes, I have done all these!). Finally my experience is that early capital networks should offer some form of engagement beyond simply deal flow (example: offering insights, networking or some other form of value). I’m not going to go into much more detail on demand-side strategies as it’s my secret sauce. If you want to know more, be in touch =)
Adverse Selection - One of the biggest challenges in private markets is avoiding adverse selection. Adverse selection and signaling risk can occur on both demand and supply sides. On the demand side, investors might be concerned that the opportunities they are being shown are second rate, i.e., deals better investors passed on. In some cases this can be justified: in many instances, founders who failed to raise from top VCs turn to “dumber money angels,” or alternative platforms like crowdfunding. Capital networks thus need to get in front of this concern providing rationale to their access, allocations and any supporting data to show these specific opportunities can outperform.
On the supply side, opportunities (startups, funds, etc.) are likely to be concerned with signaling risk. As an example, a fund manager considering raising capital on a new platform, must consider how other potential LPs might view this. Some LPs could view it as a sign of weakness or desperation. Likewise, a founder or GP selling secondaries could be seen as signaling a lack of confidence in her/his own product. The supply side may also be concerned about who the investors are. As an example some fund managers (or founder) may be sensitive to investors from certain geographies, or backgrounds.
Privacy – Related to the point above on signaling risk, is privacy. Both sides of the market are sharing extremely sensitive data. For example, family offices and LPs can be reluctant to publicly share much at all. Likewise, startups are extremely sensitive to sharing key details out of concerns for compe tition and bad actors. AngelList has pioneered a lot on the privacy front such as watermarking key documents, tracking screenshots and emails and more.
Compliance – Compliance is also a key risk when building capital networks. Depending on what type of asset is being sold or marketed, there are concerns ranging from KYC and accreditation laws to broker dealer concerns. As an example, a platform only transacting carried interest most likely does not need a broker dealer license. However, as soon as you sell shares like secondaries, you absolutely need it.
Incentive Alignement & Avoiding Bias
Another key consideration point is the overall incentive(s) of the marketplace. As an example, at On Deck I wrestled with the fact that our underlying business model was revenue from founders. The work I was doing with our investor networks was 100% in service of our founders. However, what was in the best interest of founders was not always perfectly aligned with the best interests of our investors. This is a common problem, but one that needs to be acknowledged and when possible reconciled. As an example, if an investing platform is incentivized to push its own book (it makes money based on volume of transactions) investors should naturally have some skepticism on whether deal quality keeps up with scale.
I encountered another variation of this problem when I was an active investor/LP on Orchard Platform (a fund of funds for P2P loans). Orchard started out with accredited investors as the main customer persona. Over time, however, the incentive was to move to bigger and bigger customers. Eventually the platform closed to anyone who was not an institutional investor, a frustrating experience for the folks who helped prove the business viable.
Clearly I’m a huge proponent of the power of capital networks. Once working, a well crafted capital network can create incredible economic value: AngelList funded 11,000 companies in 2022 alone.
Looking into the future, I’m excited to see more innovations that unlock access, empower entrepreneurship and drive wealth creation.
In closing I’ll highlight several trends I’m particularly excited about:
- Capital networks focused on very specific niches like fintech, or geographies (such as what Latitud has done in LatAm) or Acquire.com is doing for acquisitions. I could also see more niche communities like YPO, Tiger21 or even the All-In Podcast offering structured deal flow opportunities.
- Post-Investment Value
- Most capital network today don’t enable investor involvement post-investment. I could see a capital network develop designed to activate investors post investment, offering tools and workflows to enable value-add. Cabal might be well situated here.
- Another variation could be a capital network with fintech like offerings. For example, being able to extend lines of credit to investors or GPs
- New Asset/Structural Innovations
- Marketplaces founded on new offerings like derivatives or novel synthetic instruments. Perhaps new categories will emerge like transacting carried interest or pro rata.
- Web3-enabled Networks
- I’m an LP in Orange Fund/DAO. Some of the capital network infrastructure they have built is truly innovative and next level.
- Data & AI enabled networks
- Enhanced personalization
- Superior Curation: Opportunity selection using 1st or 3rd party data plus ML/AI. Some funds like Correlation and SignalFire already have made inroads here.