Introducing Funds, Part 2: Why Invest?

This is part 2 in a 4 part series introducing Funds.
Part 1: A quick overview!
Part 3: Why be a partner?
Part 4: What if I am unaccredited?

If you are an accredited investor, you can now invest in Funds.

Think of it as a micro-VC, or thematic startup investing. Choose an area you'd like to invest in and a team of experts will pick the startups that get funded. It looks like this:

We believe our funds will lead to a better experience for investors. Our top reasons:

Leverage the wisdom of the experts. We recruit partners that are experts, makers, operators, technologists, & founders who are on the cutting edge of their fields.
Access to higher-quality startups. The partners are insiders who often see the best early-stage deals first and can often convince those founders to let them invest. Funds will also invest in startups that may not run a Reg CF crowdfund campaign.
More skin in game & better terms. If the fund invests, the partners must first personally invest on the same terms, so they will negotiate reasonable terms.
Better due diligence. For each fund, we select partners who are operators and founders with deep expertise in their industry. They will compile a report.
Insider access to make follow-on investments. Every time the fund makes an investment, or has pro-rata, investors will receive a due diligence report card. Investors often have the option of investing more in that specific startup.
Stronger reputation & value. The combined reputation and value that our partners can bring to a startup can outcompete the majority of subpar VC's that lose money.
Fast decision making that doesn't miss the outliers. Our funds are structured to decide fast, and avoid the "death by committee" that passes on innovative outliers. Funds can execute an investment within 5 days; some, 48 hours.
Bet on and support specific industries or causes. Investors can impact the world by directing more capital to the issues they care about or believe strongly in.
Pay as little as $0 on capital gains taxes. Some of our funds qualify as Opportunity Funds, which have very strong tax incentives.

This post explains how this works in more detail.

How is this better than a traditional VC?

Venture Capital, like startup investing, obeys the power law. A handful of VC's (Sequoia, a16z, et al) earn most of the returns, as their insider network and reputation gives them a significant advantage. But those are the outliers. Most VC's lose money.

Our goal is to offer better returns to investors by innovating on the venture capital model at the early-stage. We've applied lessons from the best VC firms while decentralizing the decision-making to front-line experts who will personally invest.

The "Wisdom of the Experts" make better decisions

Part of Wefunder's mission is to democratize investing in startups. We also believe this leads to superior returns. A crowd of experts is wiser than one expert, and, only if structured properly (more on this later), should make better investment decisions.

By leveraging the wisdom of the crowd, Wefunder has already outperformed top-tier VC's. From 2013-2014, Wefunder invested out of funds into tech startups like Checkr and Ginkgo Bioworks. For these vintage years, our unrealized IRR is 53%.

We're now taking the "wisdom of the crowd" to the next level by merging it with the "wisdom of the experts" - the partners in our funds. These partners are pioneers, experts, founders, operators, and other industry veterans. The secret to their success: they are not all 'professional VCs'. They have day jobs which keep them on the cutting edge of innovation - the very basis of their superior decision making.

A startup is an act of insanity against the conventional wisdom. It is by definition an idea that - at the earliest stage - most people find stupid. If the idea didn't seem stupid, it would have already been done (Airbnb, Uber, Reddit, et al). So instead, most VC's either wait until the idea is proven (i.e., dramatically decreasing their returns) or blindly follow the hot new thing after it's a fad (i.e., missing the boat).

Who gets the new crazy idea first? Typically the first users and customers of the startup... or those pioneering experts who live - every day - on the cutting edge.

We recruit those people as partners. And if they personally invest, our funds invest.

More skin in the game

The partners in a traditional VC firm contribute only 1% of their personal capital to the fund. Traditional VC partners don't personally invest in each deal.

In contrast, our funds require partners to cumulatively personally invest between 5% to 50% (varying by fund) in each deal on the same terms. Only then can the fund invest. This has a number of advantages for investors, but the main one is aligned incentives: for each deal, the partners will lose money if they make the wrong decision, but will earn money if they help those startups succeed.

Access to good deals

There is one common mistake that many new to startup investing don't immediately grok: access is not guaranteed. You can't call up your broker and order shares of the next Uber or Airbnb. Only the "insiders" even see those deals.

In 2014-2015, Wefunder managed the "Orange Fund" that invested in YC Alumni. In this case, we were "insiders" of sorts because we were also alumni of Y Combinator. The founders liked us. They trusted us. We hung out together. They respected us. We saw the best companies before most investors could, and, when we wanted to invest, the founders often let us.

We want to apply this model to all industries. We believe those operators on the ground see these deals first, and have the reputation to be able to get access.

First look at follow-on investments

Unlike most VC's, after the fund makes an investment, the investors in the fund have the option of investing more in that startup through a single-purpose vehicle. The same applies for any pro-rata rights the fund has during follow-on financings.

For each deal, investors will get a report card summarizing the due diligence the partners performed. You can then decide if you'd like to make an additional investment in that specific company.

In essence, by investing in a fund, you are hiring a team of partners to scout out good companies, vet them, negotiate terms, and help them succeed. You then get first choice on investing more in the companies you like.

A strong reputation & value beyond capital

The top venture firms are successful because of their past reputation. Once founders see an investment from a VC as a "good signal", the best founders come to them first. When you have the first pick in the draft (so to speak), it takes a decade of incompetence to screw that up.

Our funds are a way for experts to combine their personal reputations, to increase the value of the "signal", immediately, to compete among the best investors.

Let's say you were starting a company to create miniaturized space satellites. Would you want to take investment from a fund run by MIT/Stanford/NASA/JPL technical experts? Very likely. It would likely send a strong signal to other investors that your technology is real. These groups of experts - compensated with carried interest - will be incentivized to help. Perhaps they would help you recruit, or even join your company.

How do Funds make decisions?

This is an advanced topic, but for those who like getting more into the weeds, we have strong opinions on how our funds can best make investing decisions.

We believe that the "wisdom of the crowd" or the "wisdom of the experts" only works if the decision process is structured properly to avoid group think and group biases.

Deciding by committee does not work

The answer would seem obvious: Everyone should talk it over and then vote! The majority wins! But, when it comes to startups, a model based on group consensus is a recipe for making horrible investing decisions.

The most successful startups are outliers by definition. Outliers are controversial. People either hate or love them. Committees - i.e., any group of humans - naturally seek consensus. Evolution hard-wired it into our monkey brains, presumably so we don't kill each other off (as much). Civilization must endure! However, the drive for compromise and consensus within a group is also a drive towards mediocrity - the worst decisions are avoided, but so are the best ones.

Mediocrity is especially dangerous in startup investing because of the power law - nearly all of the returns in venture capital come from just a few companies per year. You can make a hundred horrible decisions as long as you make one great one (a great one can offer a 1000x return, not a 10x return). All that matters is that great one.

So, instead of voting by group consensus, we need a way of measuring conviction, so a controversial outlier can get funded if a single partner believes in it strongly enough.

Our "votes" are personal investments

In a traditional VC firm, the general partners typically invest their personal money in the fund, usually about 1% of the total fund size.

We don't require our partners to invest in the fund (but they can). However, in order for the fund to invest, the partners must first personally invest in the startup they are sponsoring, on the same terms as the fund. Mere opinions are meaningless - if a partner has conviction, they can put their dollars on the line. The fund then matches those dollars - or, in other words, the fund matches the conviction of the partners.

Decisions should be independent

Research shows that the "wisdom of the crowd" works best when the initial decisions are independent. That is, everyone should first make a decision, and only afterwards discuss it among a group. Before they make a decision, humans are swayed too much by the opinions of others. After they make a decision, most people don't change their minds without a strong counter-argument.

One of the biggest mistakes an investor can make - that founders often take advantage of - is to base your opinion solely on what others think. This can lead to a situation where no one has actually done any due diligence because every investor assumed some other prestigious investor did (see: Theranos).

We've built our software to enforce what we consider best practice: make your own decision first before you can see the opinions of others. And then talk it over, and have the option of changing your mind based on solid debate.

Decisions should be fast

Many high-quality startups deliberately avoid angel groups because of their slow decision making and committee-driven bureaucracy. Our funds - at most - require two people to make a decision: one of the fund managers and a partner.

Our funds execute investments within 5 days - some within 48 hours. Being able to act fast is one of the most important ways of getting into good deals.

Investing is not just about the returns

We know that investors want to earn a return. But we also know that given the risk profile of early-stage investing, there needs to be another reason in addition to returns.

Funds allow investors to direct more capital to the issues they are about.

Do you want to help empower more women? Our xx fund not only is creating more female venture capitalists, but is also flying very early stage female founders to SF to help their companies get off the ground.

Do you want to help fund more first-time and early-stage founders? Our YC alumni fund does this.

Do you think America is built on immigration? Our Alien Fund is helping immigrant founders get the visa they need to build their startups in America.

Do you think more capital should be directed to long-term projects? Our Moonshot Fund will invest in the hard technology problems currently under-funded by VC's.

We can direct more capital to underserved areas. Our Puerto Rico Opportunity Fund and Detroit Opportunity Fund invest in the areas of country that really need the investment. And it's nearly tax-free!

Any thoughts or questions?

This project is currently my number one priority at Wefunder. I'd very much appreciate any of your thoughts! I'm also happy to answer any questions.

This is part 2 in a 4 part series introducing Funds.
Part 1: A quick overview!
Part 3: Why be a partner?
Part 4: What if I am unaccredited?