Software Is Eating Private Equity.

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Essays

I wrote last year that early stage capital increasingly becomes a commodity. Here is a quick summary of why:

You can do MUCH more with MUCH less. There are more free resources in business strategy and legal, in hosting, and prototyping in web and mobile, and even visualizing full UX
The top ranks of entrepreneurs have unionized, working in guilds like YCombinator and 500 Startups, and using these guilds to lead the market, create protections around deal terms, and force transparency across the industry.
The angel market has exploded. Increased public market exposure, an arms race and a talent crunch driving an active M&A ecosystem, and AngelList have made it easier than ever for someone who’s made some cash to get in the game of funding startups.

In response to this trend, it is inspiring to see First Round Capital create a new source of free, highly relevant content for founders, driving this trend further. AngelList is iterating like a startup, finding more and more amazing ways of transparently connecting capital with companies. pg created the most powerful brand in the early stage ecosystem by inventing the MBA for startups. Dave McClure and 500 Startups are reaching their arms across the world discovering and developing talent. The list goes on.** At Collaborative Fund, we have done our part to push the envelope in as many of these categories as possible, supporting crowdfunding, leading our content efforts with founders first in Fast Company and our video series, and microsites for the community.

But I think there’s another reason why venture capital is wise to innovate as quickly and as experimentally as it can: the management fee. My friend Richard Arnold of Crowdflower estimated that management fees (including carry), account for up to 500 basis points of economic activity around the world. That is trillions of dollars every year going to money managers. And for what? Their value is predicated upon information asymmetry. As an institution or individual, I let someone else manage my money because I believe they have access to better information than I do, and that their experience and network make them more capable of profitable investments than me. The former is surely no longer true. AngelList, Pitchbook, Mattermark, Crunchbase, Twitter, etc. have suggested that the information asymptotes to perfect. So then it must be that a money manager’s experience and network make them more capable. I recently heard from the managing director of a foundation that they are interested in “getting closer to the network” and that their analysts often read the same reports as the venture associates and analysts these days. In a mature social web, the networks matter more and matter less. 

When Marc Andreessen famously wrote about Why Software Eating The World, I have to imagine he realized private equity, and more broadly money management, was not going to be immune to this trend. That is more evidence still for his decision to overinvest in his firm’s experience and network. If venture capitalists want to justify their 1.5-3% fees and 15-25% carry moving forward, they will all have to look more like these innovative firms, market leaders, or else they will get squeezed, leapfrogged, and ultimately die. 

** The list is actually long. In each of those categories there are fantastic firms innovating.

 

Thanks to Ash Fontana, Rich Kerby, and Tommy Leep for putting eyes on this.

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