Startup financing has been on a tear the last two decades. From the rise of venture capital from an afterthought asset class into an industry that is deploying billions of dollars each year, to innovations in crowdfunding and revenue based financing. There has been tremendous innovation around how capital providers can support and finance the growth of new and innovative companies. Today I want to take a look at a new trend that is just really starting to emerge and has the possibility to change how venture funds finance and support startups all together.
Web3 and Crypto has been dominating news cycles recently including a massive rush of both startups looking to innovative in this space as well as investors and venture funds actively looking to fund these projects. Underlying all of this is blockchain technology which we wrote a larger piece on last week if you are interested to learn more there. This weeks discussion was spurred by a great piece by Redpoint Partner, Tomasz Tunguz, titled Crypto Companies Insider Ownership is Approaching that of Classic Startups. And the recent Sequoia Capital news that they will be shifting their fund to a single LP entity that manages investments and liquidity on an indefinite and rolling basis (with several on/off ramps for investors). It has sparked a few conversations in founder/investor groups that I am part of around the future of startups/private companies that have both a cap table and a token network and how it could lead to better alignment between startups and investors.
As more and more startups begin to build using blockchain fundamentals to structure their company we are seeing the emergence of companies that have both a cap table but also a token network of their own. Solana is a prime example where funding was raised by the Solana Foundation for development of the Solana network and token. When the network was launched (which currently has a roughly $67B market cap), investor that funded the the foundation via a traditional investment in the cap table were awarded tokens at network genesis. Obviously the terms and rate at which those tokens are awarded were part of the traditional fundraise similar to the conversion metrics set in either a SAFE or convertible note.
Now let's a take a minute and review what Sequoia Capital announced this week about the fundamental change to their fund. Sequoia announced last week that thy were permanently changing their fund structure from than of a traditional VC, Fund 1, then Fund 2 and so on, to a ongoing master fund which in turn will be and LP that will allocate capital into a series of sub-funds that will make and hold investments in startups at every stage from seed to IPO. In doing so they are shedding the traditional time-bound structure of traditional VC funds and instead allowing themselves to have a more dynamic and ongoing relationship with the founders and companies that they back. This now found flexibility also gives them tools to manage to other critically important variables, risk and liquidity.
The ability to more rapidly deploy capital into and pull it out of existing position through these sub-funds will allow the Sequoia team to more dynamically manage the rick parameters and liquidity needs of their main fund on behalf of their outside LPs. Venture has always been a very long-term and illiquid game in which funds needed to wait 5-10 years before they would know the maturity of their positions. But startups and the pace of innovation has increased rapidly and so has the demand for more rapid and fast moving capital to support these companies.
Fast-forward back to todays blockchain startups. Many of then launch with their own token that is meant to act as a currency to participate in the network, a utility token. With both a token table and a cap table, this gives investors a new and unique opportunity to buy into the startup in two areas. Take NFT gaming network and startup Axie Infinity. Investors could have invested in the cap table via a traditional equity round, and then they could invest in the native cryptocurrency of the Axie Infinity universe, the Axie. The Axie is a ERC-20 token that powers the Axie Infinity network and is required to participate in and play the game.
Like Bitcoin, it has a fixed supply and while the price of items in the game are denominated in dollars, players must use Axie's to make purchases in the game. As more and more users flood into the game and purchase Axie's to participate in the game, the more in total $ that are locked into the network increases causing the price of the token to increase. Below is the price chart for one Axie since the start of 2021.
As an early investor in Axie Infinity, if you are long on the business, imagine if you had invested in their seed round and bought a block of tokens at .54 cents. 10 months later and you can see the price in the chart above. Now trading in the $140s as a liquid asset (Axie Infinity has seen $1.9B traded in the last 24 hours at the time of writing this post). For a VC fund with a long, illiquid position in Axie Infinity's seed round, wouldn't it be great to be able to sell some tokens and take some liquidity out to either give your LPs a payout, manage risk, or invest in a new opportunity.
With the rapid pace of innovation and accelerated funding cycles we are seeing in todays markets, the ability to balance both an illiquid and liquid position in early-stage and growing blockchain startups could be a major leg up for many investors and VC funds. Combining the best of private, venture investing with the liquidity and flexibility of public markets.
Now this obviously all sounds a lot like a security since I have repeatedly used the terms "liquidity" and "investment" haha. While investors have taken advantage of this dynamic with startups like Axie Infinity and others, there certainly is a future in which this setup becomes regulated as the cryptocurrency industry grows, the need for financial regulation is certainly looming. Regulations aside, it certainly presents an interesting new dynamic for the future of startup investing. A large value prop of blockchain and cryptocurrency technology is to help introduce efficiency into capital markets. If you can remove the long-hold, illiquid nature of venture and providing investors with more flexibility and founders with more optionality should help increase the efficiency of private markets. And more efficient markets should be able to support a larger number of startups and founders.
Again, with regulation it remains to be seen how this new dynamic will play out over time. It certainly is an interesting strategy to look at and those of you who know me know that I have always been a fan of innovation around venture financing. It will be fun to watch and see how this evolves and we will be sure to keep you up to date on any new or evolving trends we notice.