Crowdfunder did it last year with the launch of their crowdfunding/startup “index” fund. Now Circleup is jumping into the startup fund party with the launch of a $125M venture fund. On the real estate side, Origin Investments has successfully launched several funds (founded by their platform) for targeted investments in real estate. These are markedly some of the first, but most assuredly not the last of their kind. The fintech platform model, when successfully implemented, lends itself to the eventual “fund” model–giving the platform itself centralized investment authority over investing directly in dealflow seen on the platform. While some funds have a very broad diversified mandate (i.e. pooled investments across all issuers on a platform), others are likely to take a much more targeted and disciplined approach. That is, they may attempt to pick winners and losers from the kaleidoscope of deal opportunities sourced online. In my assessment, here are just a few reasons platforms naturally expand their businesses into a fund model.
As platforms grow, their ability to close deals in rapid succession concurrently improves. It’s a bit of a chicken/egg conundrum. That is, a platform needs to have many quality deals to attract real, credible investors AND the deals will not come unless there is true investor interest from an active investing database on the platform. Building such an ecosystem and network online is difficult, expensive and altogether time-consumer. However, once built, it makes sense to have one’s own discretionary fund for either diversification purposes or the best deals.
The no arbitrage theory assumes that there is no such thing as a good deal as an active market will erode the price discrepancies. With intermediaries and active buyers in a large middle-market, this is less rare than ever. Smart issuers typically do not want proprietary deals. Investors do. Platform players with sufficient, quality dealflow can take more advantage of price arbitrage among middle-market players as there will be significantly less (and sometimes no) competition for the deals. It’s a private equity group’s dream come true.
Unless a platform is fully registered with the a Self Regulatory Organization (e.g. FINRA, SEC), they are likely limited in the types of fees they can charge for listing on their platform. In fact, most middle-market platforms, whether capital raise or M&A, have made the bulk of their money in the past from subscription revenue–either revenue from posting issuers or large SaaS fees from would-be investors. I could write an article that shows how most platforms also move toward a registered model at some point in order to take advantage of success fees, but the fact remains, greater revenue on both management and carry fees can be had from a fund and not just a simple pay-per-post or pay-per-engagement model. In short, registering and raising a fund helps both expand and diversify the revenue of the overall business.
The best, most successful platforms have both the quality dealflow and the ability to distribute said dealflow toward closure. With that ability, centralizing the management of the investment vehicle itself allows a platform to participate more fully in the management, underwriting, due diligence and ultimate success of the ecosystem they have built–and take more of the cut of the profits throughout that entire process.
A fund allows you to assess, evaluate and close a deal much more quickly than working on each deal in a silo. For instance, if a quality deal comes to the table a typical platform or even an intermediary working through and on a platform may have to kiss 1,000+ investor frogs to find a single or handful of meaningful, interested parties on a single investment. The investment banker or intermediary has likely done a great deal of preliminary due diligence on the deal prior to taking it to market and is likely very confident in the efficacy and opportunity the deal represents, it’s convincing those frogs that the deal is a good fit. A fund, while somewhat handcuffed by the investment thesis to which is prescribes, is less limited and more able to make snap decisions (with the help of the fund managers, of course) on which investments fit and can be tied directly to the given platform in question. Speed is the ultimate deal killer and speed can also be a necessary piece of getting a deal that much closer toward a win in a faster period.
While I do expect to see more and more funds to emerge out of what was initially only “fintech platform” businesses, I would imagine that each fund will target a very discreet investment type. For instance, the Circleup fund is focused on consumer products and brands. As I am fond of saying, focus creates wealth and diversification preserves it. It is also interesting to note that no true platform winner or fund has yet to emerge in true middle-market private equity–yet. When it does occur, I think it will happen in twos, threes and fours. Time will tell.