Reinvent Finance
Develop New Venture Models for Tougher Ecosystems
In innovation, perhaps the strongest symbiotic relationship is between entrepreneurs and venture capitalists. Without venture capital, entrepreneurs might have an idea, but no way to get it off the ground. They are willing to sell a portion of their company in return for capital and advice to accelerate it. And, of course, without entrepreneurs, venture capitalists would have no one to do the hard work of building a company.1 Yet this mutually dependent relationship can fall out of balance.
Carlos Antequera is a former entrepreneur turned venture capitalist. He is intimately aware of the idiosyncrasies of the industry and determined to chart a different path. Originally from Bolivia, Carlos studied computer science and mathematics in Kansas and later worked as a software engineer. After completing his MBA, he founded Netchemia in Kansas, originally as an internet consulting firm to help bring Latin American businesses online and digitize their processes.
Then an acquaintance asked for his help in automating special education for the local Topeka, Kansas, school district. Soon other school districts heard about the product and requested his help. Netchemia found its niche building a talent management platform for school districts to recruit, develop, and train their teachers and administrators. Netchemia then scaled to become a dominant national player in the United States and to serve more than thirty-five hundred school districts, over time helping them with a range of products spanning job boards, applicant tracking, employee records, and performance management.
Carlos built his company without traditional venture capital. He bootstrapped Netchemia for four years until he raised a seed round of $850,000 from angel investors. Many years later in his journey, to support some investments in the business he received a $6.5 million private equity investment, essentially skipping the venture capital stage.2
Reflecting on his experience, Carlos concluded that classic venture capital wouldn’t have worked for his business. Netchemia had a strong business model, good growth, and highly predictable revenue, but it had neither the potential nor the ambition to scale a hundredfold. As a growing technology business with limited collateral, the company also wasn’t a great fit for bank loans.
The venture model did not work for Netchemia, nor does it work for many companies like it. As Carlos explains, “If I had wanted Netchemia to be a fit for a venture capitalist, I would have had to break what I already had. Venture capitalists need bigger markets to invest in. I would have had to move away from a niche market and swing for the fences on a larger idea. But by going to a larger market with no expertise, I would likely lose everything I had so painstakingly built.”3
In 2016, fifteen years after starting it, Carlos sold Netchemia to a private equity firm. As his next step, he wanted to find a way to financially support more entrepreneurs like him who were building companies like Netchemia that were incompatible with traditional Silicon Valley–style venture capital.
What was it about the venture capital model that was so incompatible with Carlos’s desired investments? To understand that, let’s first explore the basic principles of classic venture capital typically associated with Silicon Valley.
Venture capitalists are specialized investors in startups. They raise funds—pools of capital—which they invest over three to four years; then they help their investments mature and ultimately exit. An average fund has a life-span of ten years. To continue investing, the venture capital firm raises a new fund every time it has finished investing the first one. The general partners (the venture capitalists) invest the capital of limited partners (family offices, pension funds, university endowments, foundations, and corporations) who entrust their capital with the fund. Venture capitalists have a nearly universal business model, which is composed of a fee and profit-sharing system (often referred to as “2 & 20,” the typical fee structure for venture capital funds, consisting of a management fee and “carry,” explained shortly).4
When I ask my students where they think the classic model originated, they often bet on the earliest days of Silicon Valley. But its roots are much older and have nothing to do with tech. In fact, the now-standard profit-sharing structure was pioneered in the 1800s in New Bedford, Massachusetts, for a completely different industry: whaling. While New Bedford was only one of many ports that supported the whaling industry, it dominated the trade on a global scale. As the Economist observes, the whalers in New Bedford “did not invent a new type of ship, or a new means of tracking whales; instead, they developed a new business model that was extremely effective at marshaling capital and skilled workers despite the immense risks involved for both.”5 Of the nine hundred whaling ships worldwide in 1859, seven hundred were American, 70 percent of which hailed from New Bedford.6
The New Bedford whaling model worked in a strikingly similar way to the modern venture capital system. Whaling agents (the equivalent of modern-day venture capital firms) recruited investors and put up capital to buy and equip the boats. For this, they would receive a share of the profits (a portion of what one could “carry” off the boat). The captains (our modern-day entrepreneurs) often also invested their own capital in the voyage and received a meaningful share of the proceeds. The crew was paid entirely from the proceeds of the voyage, much as modern-day stock options reward startup employees. The timelines were long: boats would return only when the ship was full, something that could often take years, and a meaningful percentage of boats were lost at sea.7
Like mid-nineteenth-century whaling, venture capital is a risky investment strategy. Each unique investment in a startup has a high risk of failure; a reputable San Francisco research firm recently predicted that there is a less than 1 percent chance of a Silicon Valley startup becoming a unicorn. Some 70 percent of startups fail.8
The risk inherent in the venture capital model is offset by its potential rewards. Successful investments in startups don’t increase by 10 percent to 20 percent, as the stock market might, but by 100 or 200 percent, and sometimes much more. Through their funds, venture capitalists make multiple bets and hope that the returns from a small number of winners will more than pay for the losses accrued along the way.
These investments can be highly profitable; to take an extreme example, the Silicon Valley venture firm Accel returned a rumored $9 billion on its original $12 million investment in Facebook.9 Similarly, when Sequoia invested in WhatsApp, its stake was rumored to be worth as much as $3 billion at exit, more than fifty times the original investment.10 Although both of these transactions are outliers, they illustrate the economics at work. A few highly positive financial outcomes tend to dominate a venture capital fund’s returns and cover the losses from the rest of the portfolio. Overall, venture returns are attractive, averaging 9.6 percent annually over the last ten years, and nearly 20 percent over the last thirty years.11
The venture capital structure, however, also comes with its own incentives and particularities, which in turn influence how the innovation industry behaves. Funds have ten years to invest and return capital, a practice that sets the finish line when an investor is looking to exit. Funds are structured with 20 percent carried interest (funds receive 20 percent of the returns they generate for their investors), and so they search for startups that can garner sufficiently large profits that maximize capital gains in the desired timeframe. The 2 percent management fee pays for the operation of the fund.
Unsurprisingly, this model doesn’t work everywhere.
The Reality of Venture at the Frontier
Despite its global dominance, the traditional venture capital model does not perfectly translate to the world outside Silicon Valley. Like the Frontier Innovators they serve, venture capitalists in emerging ecosystems face unique challenges.
Of course, a dearth of capital is a key challenge. Whereas Silicon Valley has nearly a thousand venture capital funds, Africa’s fifty-four countries together account for fewer than ninety firms (fewer than two per country).12 Latin America has fewer than 150 firms across the entire region.13 This disparity also extends to the United States, where the entire Midwest accounted for a mere 0.7 percent of national venture capital investment (versus 40 percent on the West Coast).14
Compounding this, macroeconomic conditions, such as those explored in chapter 3, create more uncertainty for Frontier investors and challenge returns. A 30 percent drop in one country’s currency would cause a meaningful hit on an investor’s return.
Timelines to exit are also longer. Whereas in Silicon Valley, a venture investor can count on a ready corporate acquisition ecosystem and stable IPO markets, in an emerging ecosystem neither is a given.15 On the surface, the combination of limited capital, dependence on other investors, singularly challenging exits, and macroeconomic risks paints a dismal picture.
Despite these manifold challenges, Frontier venture capital funds are demonstrating viability, and often they are uniquely attractive business models. Cambridge Associates, an investment consulting company, estimates that the average return for emerging-market venture capital and private equity over the past fifteen years is more than 10 percent.16 Other, specialized indexes suggest that emerging market returns exceed US performance across multiple vintages.17
Some of the strategies used by leading Frontier investors to accomplish this feat include constructing a resilient portfolio, becoming born global themselves, and taking a long-term outlook.
Portfolio Resilience
The venture capital portfolio at the Frontier has a distinct risk and return outlook than in Silicon Valley.
Venture capital firms rely on a few investments to carry the entire fund, because for every business idea there will always be multiple companies trying to build it, and only one will end up dominating the market and making money for the venture capital firm. For every Facebook, there was a Myspace. When a business succeeds, startups raise a large sum of capital to capture market share rapidly before anyone else does. The power law, as noted in figure 10-1, describes this paradigm. Unlike normal distributions, in a power law the top couple of companies see outsized success, and the remainder see mild to no returns.
The power law translates to venture capital as well. Estimates suggest that after fees, half of all venture capital firms don’t return their capital (a zero or negative rate of return), and only 5 percent return more than three times the capital (the equivalent of 12 percent annualized return over ten years). This means that after ten years, half of venture capital firms provide worse returns than comparatively investing in low-interest checking accounts (at a much higher level of risk).18
Even when half of firms perform poorly, however, the average industry return remains quite attractive. That’s because returns are highly concentrated among a few firms and, within them, in a few deals that generate most of the returns.
At the Frontier, these dynamics are more nuanced and less extreme.
As you have seen, Frontier Innovators are building their companies differently from their Silicon Valley counterparts. While still growing, given that typically there aren’t five competitors vying for the number one spot, Frontier Innovators are more concerned with having strong business models and enjoying repeatable growth than with making an all-out land grab. Being a Camel may lower the speed at which outsized success is reached, but it decreases the likelihood of a total bust. Indeed, research suggests Frontier startups have higher survival rates than those in Silicon Valley.19 This means venture capitalists at the Frontier invest in startups with a lower failure rate.
The downside to lower failure rates is that, so far, stratospheric success is rarer. With the exception of China, no other region has been able to consistently generate as many unicorns, or unicorns as large, as Silicon Valley in the past decade. Globally, the United States has more than half the unicorns, and China accounts for another quarter. Except for Germany, India, the Netherlands, Russia, the UAE, and the United Kingdom, no other country has yet seen two or more unicorn exits. The entire continent of Africa recently saw its first startup IPO: Jumia. Even in the United States, outside California and New York the vast majority of states cannot lay claim to a single unicorn.20
While academic research on the topic is still emerging, early data suggests that Frontier venture capitalists have a lower likelihood of outsized unicorn-level success, but also a lower likelihood of failure, since they are building profitable and sustainable businesses. This does not mean venture capital at the Frontier does not depend on outsized winners; it does. However, the portfolio mix is different. Figure 10-2 explains this dynamic.
The Southeast Asia venture capital firm Asia Partners studied the Sharpe ratio (the amount of return for a given amount of risk) of venture capital in Southeast Asia relative to other asset classes. Venture capital was among the most attractive across any category and, remarkably, offering the same level of risk-adjusted return as real estate.21
To enhance resilience in their portfolios, Frontier venture capitalists also collaborate with other investors. This syndication reduces risks in investments in two ways. First, each fund doesn’t need to allocate quite as much to a single deal. This allows smaller funds to diversify their portfolios. Second, syndication ensures there are more players around to help fund companies when they raise subsequent rounds.22 Syndication is also correlated with higher likelihood of exits at higher valuations.23
In Silicon Valley, syndication is increasingly uncommon (except at the earliest stages). The size of venture capital funds has continued its inevitable march upward, with many leading investors consistently raising more than $1 billion.24 As a result, Silicon Valley investors often look to write larger checks (smaller ones would be immaterial to a billion-dollar fund) and acquire meaningful ownership (so that in the event the company is a success, the investor reaps a larger share of the rewards). These dynamics in turn make it harder to syndicate deals or allow other funds to participate.
Frontier investment dynamics such as syndication may signify a “what’s old is new” moment for those who have studied the history of Silicon Valley. In the original days of Silicon Valley, most funds also collaborated.25
Born Global Diversification
Historically, venture capital was a local game. For good reason: to successfully support entrepreneurs requires deep knowledge of industry pain points, the political and regulatory landscape, and economic dynamics. It’s also because Silicon Valley investors prefer to invest closer to home. An analysis of venture capital funds found that nearly two-thirds of a typical Bay Area–based investor’s portfolio was in the Bay Area, and 80 percent in the West Coast.26
For many Frontier venture capitalists, multiregionalism is intentionally woven into the fabric of the firm. Just like the born global startups you met in chapter 5, many venture firms adopt a multimarket approach from the get-go—out of necessity. Creating a single-market venture capital firm is challenging. Frontier businesses by their nature scale across multiple markets, and thus the winner in any country might be local or originate somewhere else.
Moreover, innovation trends are no longer unidirectional from Silicon Valley and now follow a global supply chain. Compounding this, in more-developing ecosystems (particularly for deals beyond Series A and B, outside the largest emerging markets like Brazil, China, and India), there is rarely enough deal flow to support a single fund. Consequently, firms expand across geographies to find a sufficient flow of deals. Born global startups face competition from everywhere. Accordingly, their investors often organize themselves to invest across borders, spotting trends in other geographies early and helping scale their portfolio companies into global (or at least regional) category leaders.
Cathay Innovation, for example, is a firm that is international by design, with a global footprint and offices across Asia, Africa, Europe, and North America. Its vision is to create a global platform that shares lessons on trends in innovation, includes international corporations to support entrepreneurs, and assists portfolio companies in expanding across markets.
Long-Term Outlook
Time-based constraints (typically in Silicon Valley venture capital) force investors to think within a certain timeline, thereby restricting a startup’s growth trajectory and the entrepreneur’s needs. This practice runs counter to limited partners’ interests, who are focused on long-term maximization of capital.
These time constraints are a major challenge for venture capitalists at the Frontier, where, as you have seen, timelines to exit are longer. To tackle this challenge, the approach I find most compelling is an evergreen fund.
Investors using evergreen structures have no fixed timeline to return capital to limited partners and continue to reinvest as profits come back. Naspers, a South Africa-based conglomerate and a leading global Frontier investor, effectively has an evergreen investment structure.
Naspers’ first venture investment was in Tencent. Naspers’ CEO was looking to acquire a Chinese media company. In 2001, the team stumbled upon WeChat, a communications app that many entrepreneurs were using to communicate. What began as a takeover discussion morphed into an agreement to purchase nearly half of Tencent for $32 million. Nearly two decades later, Tencent’s market capitalization is more than $500 billion, and Naspers’ stake is worth more than $100 billion (over the past ten years, Naspers’ own market valuation skyrocketed from $1 billion to more than $100 billion, largely on the back of this single deal).27 This investment is arguably the most successful venture capital deal of all time.28
Since then, Naspers has invested around the world and has grown its footprint to include offices in Brazil, Hong Kong, India, Israel, the Netherlands, Singapore, and South Africa.29 Freed from returning capital to investors within a time-bound fund, as a publicly traded company Naspers can take long-term bets, such as Tencent, and hold them to fruition.
Similarly, Vostok Emerging Finance (VEF) was founded in 2015 to invest in financial services startups across the world. VEF is publicly listed on the Stockholm exchange, which allows it to hold positions as long as it needs.30 As an evergreen fund, VEF can be flexible on stage, investment size, and deal structure. VEF has already invested in a range of early-and late-stage companies across the world.31
While Naspers and VEF are publicly traded companies, evergreen funds can be private structures as well. For the moment, neither private nor publicly traded evergreen structures are common. Since the structure is not mainstream, many limited partners are not yet comfortable investing in evergreen funds.32 Another solution investors are experimenting with is long-dated funds (i.e., longer than ten-year funds).33
Although still outside the mainstream, these fund structures signal an important trend within Frontier finance: investors have recognized the need to take a longer-term outlook.
Just as investment tools, portfolio construction, and fund design are changing, so too are the players. New players include corporate and impact investors.
Corporate investors are a major driving force behind Frontier ecosystem development. By contrast, in Silicon Valley, large corporate investors take a bifurcated approach. For many, their primary concern is acquiring companies. They watch startups mature and then purchase the ones they deem most synergistic with their operations, or most threatening to their long-term vitality. Facebook’s purchase of WhatsApp and Instagram—two rapidly up-and-coming social networks it couldn’t replicate nor allow to succeed—illustrates the latter scenario. Some corporate investors go one step further and invest through dedicated vehicles, largely corporate venture capital funds (CVCs). Although CVCs are on the rise in Silicon Valley, traditional investors dwarf them in scale.
This dynamic is reversed in many parts of the Frontier, including in China. In China, powerhouse technology players like Baidu, Alibaba, and Tencent (often referred to by the acronym BAT) are dominant investors and partners of startups. Unlike their Silicon Valley peers, they don’t merely invest capital or seek to acquire companies. Leveraging their platforms (such as Tencent’s WeChat or Alibaba’s Ant Financial, its payment affiliate), they can offer powerful distribution and support through their ecosystems. The BAT investors have backed and partnered with more than a quarter of China’s unicorns.34
Chinese corporate investors are affecting other ecosystems as well. Ant Financial, itself a rapidly growing startup (at the time of writing, it is set to go public at more than a $100 billion valuation, eclipsing Silicon Valley’s largest startup by a wide margin), raised nearly $3 billion specifically to fund emerging-market financial services companies.35 Tencent reportedly invested $30 billion in companies between 2015 and 2017, including companies like Snapchat, Spotify, Tesla, and Uber.36
In Southeast Asia, corporate investors have become important growth-stage investors. They are currently funding the ongoing ride-sharing battle between Grab, a Singapore-based startup that has raised billions and is backed by Alibaba and Softbank, and Gojek, Indonesia’s key player, backed by Tencent and JD.com (one of the biggest technology e-commerce companies in China).37
Of course, the rise of corporate investment is not only a Chinese phenomenon. Naspers, perhaps one of the largest Frontier investors, is a corporate investor. In fact, the largest venture capital fund in the world is run by a corporate investor. In 2016, Japan-based SoftBank launched the Vision Fund and raised nearly $100 billion to invest in startups around the world. SoftBank recently raised a separate $5 billion dedicated fund for Latin America.38
Between 2013 and 2018, CVC investment grew fivefold—from $10 billion to more than $50 billion—and now CVCs participate in nearly a quarter of all deals (versus 16 percent in 2013).39 There are more than a thousand major corporations with CVCs, including seventy-five of the Fortune 100.40 This number includes everyone from Salesforce.com to Sesame Street. CVCs are increasingly international: 60 percent come from outside North America.41 If the Frontier is any indication, global CVCs may look less like those in Silicon Valley that invest or acquire, and may instead follow the nurture-and-partner model espoused in China and elsewhere.
The Rise of Impact Investing
Chapter 8 highlights the balancing act Frontier Innovators maintain as they work to prioritize both social impact and business success. Similarly, a cadre of investment firms are increasingly pioneering and scaling impact investment. Indeed, impact investments are a driving force at the Frontier.
Omidyar Network, my previous firm, was one of the first impact investing funds. Omidyar Network has a unique structure, marrying a nonprofit with a traditional LLC venture capital model. This arrangement allows its investment teams to exercise great flexibility in making both grants to and investments in entrepreneurs around the world.
When it started, Omidyar was one of a few funds in a burgeoning sector. Now impact investing is an increasingly crowded field. Many foundations and nonprofits have gravitated to the model, because capital can be returned and reinvested and can support a wide range of institutions. At the other end of the spectrum, much larger, traditional financial institutions are also taking up the mantle. In 2017, the Texas Pacific Group (TPG Capital), one of the leading mainstream private equity groups in the world, closed a $2 billion impact investment fund.42 The Ford Foundation recently announced that it had earmarked $1 billion from its endowment for mission-related investments. Since the term impact investing was coined at a Rockefeller conference in 2007, more than $220 billion in assets has been committed to the impact sector.43
Like Multi-Mission Athletes, in emerging ecosystems Frontier venture capitalists increasingly support organizations whose impact is intrinsic to the business model. All investors have an important role to play in supporting Frontier Innovators—and all entrepreneurs—in their quest to create businesses that matter and have transformative impact.
Challenging the Typical Investment Structure
Many of the leading Frontier Innovators profiled in this book, such as Gojek, Grubhub, and Guiabolso, were funded through traditional venture capital structures as well as corporate and impact investors. That’s normal. This model is still by far the dominant option.
But many investors at the Frontier are beginning to experiment with new models, including creating new investment structures, leveraging artificial intelligence to source and make decisions, and allowing users to invest.
In 2016, Keith Harrington, a venture capitalist in the US Midwest, was experiencing ever-mounting frustration with the traditional venture capital model. Few companies he was encountering were venture backable. “They were great businesses,” Harrington explained, “but they weren’t a fit for the traditional venture capital models. By all accounts, they were growing impressively, often over twenty percent a year. This of course is slow for a startup . . . [They] were bootstrapped [having never raised venture capital] and closely watching cash and managing profitability.”44
Because venture capital found its inspiration in one specific resource industry—whaling—Keith Harrington was exploring other industries for ideas. He struck gold in mining, which relies on a royalty system. Prospectors pay their investors a certain percentage off the top over time. Investors therefore share in the upsides and downsides of the business; they get paid only if the prospectors are successful, and, if things don’t go well, there are fewer payments.
Keith joined forces with Carlos Antequera of Netchemia, and Novel Growth Partners was born. The two men proposed an alternative mining-inspired solution to fund startups: a revenue share. Instead of buying equity in the business, they would purchase a portion of a company’s revenue for a certain amount of time.
The revenue share structure addresses two challenges simultaneously: lengthy investment duration and the risk of not finding an exit. Unlike the traditional model, revenue shares offer ensured liquidity. To get their capital back, Silicon Valley venture capitalists need to wait for somebody else to purchase their equity, an eventuality that requires the company to be acquired or to go public—outcomes that are far from certain. A revenue share, however, is based on current revenues. For many companies, future revenues in the next two to three years are relatively predictable. Investors get an ensured exit and payouts on set schedules. Entrepreneurs benefit from the control that revenue shares afford them, since investors don’t own any stock in the company.
One of Novel’s first investments was in MyMajors. Although it was started in 1964, it had recently developed an algorithm to help match college students to academic majors. The software fills a crucial and yet often overlooked niche. As Keith notes, “Most colleges are graduating students in six years or more. The reason is that students flip majors. It’s a problem for everyone. Colleges are trying to figure out how to increase retention rates and graduation rates. Students are looking to reap maximum value from their education.”45 MyMajors helps students focus early on promising areas of study.
These types of “novel” revenue share structures are still very early, but they are gaining traction in the venture capital industry and will continue to proliferate. Already, there are at least eight revenue-based funds in the United States. Unsurprisingly, they sprang up predominantly outside Silicon Valley, including in Dallas, Park City, Toronto, and Seattle.46
Computerized Decision Making
Artificial intelligence is becoming an increasingly important tool for venture capital sourcing and decision making in both Silicon Valley and the Frontier. More than eighty venture capital firms globally have publicly disclosed their artificial intelligence models. Many others are likely doing this privately.47
Because there is less capital available at the Frontier, the distance to travel is longer, and the cost of assessing investment opportunities in different countries is higher, data-driven techniques are valuable tools for investing in Frontier Innovators.
For example, Clearbanc, a Toronto-based startup that offers startups revenue shares, has pioneered an automated process. Startups connect their bank and social accounts, along with detailed transaction logs. The speed and impartiality of Clearbanc’s model is particularly striking: startups can receive a revenue-share term sheet in twenty minutes.48 Similarly, Social Capital (which is no longer raising outside capital) pioneered a model called capital as a service, or CaaS, which created algorithms to benchmark and predict companies’ performance objectively. If Social Capital’s algorithm liked what it saw, the company would write a check for as much as $250,000.49
Historically, venture capital decisions reflected an art of analysis and were based on consultation with the fund’s partners. Clearbanc and Social Capital’s CaaS is algorithmic. It verifies data, makes decisions about funding, and offers advice.50 By focusing only on impartial metrics, these companies invest in founders who might otherwise be overlooked. Among Social Capital’s more than seventy-five CaaS investments, 80 percent of founders were nonwhite and 30 percent were women, spread across twenty countries—statistics far above traditional industry numbers.51
It is unlikely that computerization will completely replace the human venture capitalist; nor should it. After all, in startup investments, qualitative factors like deal structure and team dynamics are critical. On Wall Street, hedge funds have perfected the use of artificial intelligence–driven trade decisions to get microsecond edges on the market, but in venture capital, timing is less urgent, and thus there is time for human review. What’s more, the human factor between investors and entrepreneurs matters a lot (I remind my students that the average venture capital relationship is longer than the average American marriage).52 At the Frontier, although artificial intelligence is poised to be an insightful tool, it likely won’t be replacing investors any time soon.
The Most Nascent of All: Customers
Arguably, the newest investor at the Frontier may be customers themselves. Historically, in traditional venture capital, investors in startups were disconnected from the user base (e.g., rarely do Uber riders own stock in Uber). In the majority of markets, an investor needs to be accredited (in the United States, a would-be investor must make more than $200,000 in salary or have more than $1 million in liquid net worth) to legally make investments directly in startups.53 Rarely can employees or users of startups purchase stock (except for stock options). Many founders seek a better way; they want their communities of users to also participate in the benefits that their usage generates.
Innovations in the cryptocurrency space may turn this paradigm on its head. Initial coin offerings (ICOs) are a form of crowdfunding. Unlike an IPO, in an ICO investors do not receive shares in the business, and, unlike traditional crowdfunding campaigns, investors are not promised a particular product or experience. Instead, ICOs represent the sale of a token that grants access to the ecosystem or network that the entrepreneurs are building.54 The number of available tokens is generally finite, and so as the network becomes more popular, the demand and thus the value of the token rises.
Many have heralded the rise of ICOs as a game-changer for the venture capital ecosystem. In 2017, entrepreneurs raised a staggering $6 billion in ICOs.55 But if this seems too good to be true, you might be on to something. The legality of ICOs in many parts of the world is still in question. Many ICOs lose money. Shockingly, some estimates suggest that as many as 80 percent of the first wave of ICOs were fraudulent.56 Of the honest projects, they were often very early stage projects that amassed gargantuan sums of capital with a very limited business plan.57 Many of these projects will naturally fail. Over the past year, the ICO industry has slowed considerably and regulators have started cracking down on the model.58 A reckoning in the early ICOs is likely.
ICOs are a very specific part of a much broader trend: the rise of crowdfunding. Platforms like Kickstarter and GoFundMe have provided options for entrepreneurs everywhere to access nondilutive capital and prove demand for their products. In the United States alone, crowdfunding has raised more than $17 billion in 375 separate platforms.59 By mid-2019, crowdfunding in China had raised eight times the US amount.60 Recent regulation, including the JOBS Act in the United States, will make it easier for individuals to invest in startups. These models allow entrepreneurs from anywhere to access capital.
Much like the rise of impact investors and corporates, individual investments in startups is certainly a trend to watch and may help bridge a lack of capital over time.
Lessons from Early Advances in Venture Capital
It is still early days for venture capital at the Frontier. The majority of innovators profiled in this book depended on traditional venture capital funding, in part because that was what was available.
Building solutions that work for local ecosystems is paramount. In chapter 11 you will meet Erik Hersman, the founder of BRCK and Usha-hidi, two high-profile startups in Kenya. As Erik explained, “You’ve got to make sure the tail doesn’t wag the dog. Today, many startups depend on Silicon Valley for funding, so they tell their story to match the practical reality [of raising capital from existing investors].”61
Startup strategy should not be dictated by the subjective constraints of a geographically specific venture capital system that itself is derived from a long-forgotten industry. Silicon Valley has adopted an “if it ain’t broke, don’t fix it” attitude toward the current venture capital model. But, increasingly, it is where things are broken that we are seeing true innovation. Venture capitalists at the Frontier—entrepreneurs and innovators in their own right—are reinventing the model according to the needs of their investees.
One thing is certain: the next industry standard will not derive from whaling ships on the high seas. Rather, it will emerge on the shores of Frontier ecosystems.