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EXCLUSIVE: Joe Reilly Talks To David Teten About Venture Capital, Technology And Angel Investing

Joe W Reilly

3 February 2014

This month, family office consultant Joe Reilly has an in-depth interview with David Teten, partner at venture capital firm ff Venture Capital and founder of the Harvard Business School Alumni Angels of Greater New York, about how technology will disrupt wealth management, angel investments for family offices and crowdfunding. This is part one, part two will run in the next few days. 

Joe Reilly: Your firm was the first alternative asset manager in the US to advertise that you were raising money, taking advantage of the new regulations in the JOBS act.  What led to the decision to stick your neck out?

David Teten: Because we’re not only an investor in social media companies; we’re also a heavy user and believer in the power of social media.

Historically, institutional investors kept their investing strategy and their activities very discreet.  Today, however, some are aggressively employing social media tools to discuss their strategies, deals in the pipeline, and even their political views and sporting accomplishments.  ffVC is in that bucket.

According to Jeff Bussgang, general partner at Flybridge Capital Partners, about 10 to 15 per cent of the 1,000 active venture capitalists in the US write blogs.  Fewer private equity funds are using social media for outreach, but 2xPartners, Healthpoint Capital, and MCM Capital Partners are notable exceptions.  Many investors remain ambivalent about social media because the advantages of using it are not always apparent, while the detractions can be very clear.

Private equity investing is a relationship business.  As more of our personal relationships move online, social media becomes a very cost-effective way to strengthen a firm’s corporate relationships.  Robert Bruner, Dean of the Darden School of Business, observed in an interview that social media is particularly important in origination because of the significance of “weak ties” in identifying investment opportunities.  In addition, he predicted that the rise in importance of online networks will make the most credible players even stronger.  I suggest the reason for that is: as people consider doing business with others that they know primarily online, a known brand becomes a significant expediter of a potential transaction.

In 2010, I published the first study of best practices in deal origination with my co-author Chris Farmer.  We found that some of the best-performing investors are benefiting from openly discussing their investment theses; doing so increases their perceived expertise and trustworthiness, and thus generates qualified dealflow.  Our research indicates that for these social media-savvy funds, their visibility to investors and potential portfolio companies more than makes up for whatever competitive edge they lose by giving outsiders insight into their activities.

Social media is valuable for more than just origination.  One of the core assets of a fund is its corporate network.  Investors can tap this network for executive talent, follow-on financings, and eventually an exit.  For example, many VCs, including First Round Capital and ff Venture Capital, have made their websites hubs for job seekers, because their portfolio companies by definition are growth firms constantly in need of the best talent.

Moreover, some investors use social media specifically to reach out to companies flashing relevant “deal signals” in order to filter the universe of companies. These investors are exploiting the wealth of information about private companies available online, increasingly leaked via social media.  For example, an increase in internet traffic is usually a sign of customer traction.  A family-run company that hires an outside CEO is flashing a signal that the firm may welcome an outside investor.  Prior to joining ff Venture Capital, I was working on a startup, Navon Partners, with technology designed to source new transactions based on these signals.

Given how much data PE firms can gather about other investors and companies through social media, it is understandable that they are wary of making too much of their own information available through those channels. Although Fred Wilson of Union Square Ventures is arguably the single most prominent VC blogger, even he has his reservations: “Our entire firm was pretty public about our interest in Foursquare.  The Foursquare financing was among the most competitive early round financings I’ve seen in a long time.” There are many people in the investment business that believe you have to play your cards close to your vest or you’ll get burned. And I understand that approach. And there was certainly a few times during this transaction when I regretted how public we were with our interest in Foursquare.”

In addition to a blog, ffVC operates accounts on Facebook, Twitter, and LinkedIn.  ff actively uses our blog, Facebook, and Twitter to promote portfolio companies and post value-added content.  Facebook allows for branding and recruiting targeted towards young entrepreneurs and college students; Twitter reaches a more general audience. Our blog uses Livefyre, one of our investments, for comment moderation to increase user engagement.

Joe Reilly: Do you think technology will disrupt the asset management industry?

David Teten:  My number one learning from my time in the asset management business is: this is a highly unusual and somewhat baffling industry.   The industry shows the traditional earmarks of an industry ripe for disruption - most obviously, unhappy customers and extremely profitable incumbents.

Despite this, it’s hard to think of good examples of disruption to asset management in the classic, Clay Christensen sense. The best examples I can think of include index funds like Vanguard; ETFs like iShares; crowdfunding groups like Indiegogo, which is one of our investments; discount online brokerages like Charles Schwab; online wealth management like Wealthfront; back-office management like Addepar, also one of our investments; and principal-protected investments like JP Morgan and many others now have done; and expert network investment research such as my former company, Circle of Experts.  I think there are more opportunities to disrupt the space. 

Almost every other industry collectively does what it promises; the restaurant industry does give all its customers food.  However, the asset management industry collectively plays almost a pure zero-sum game.  Each new investor tends to raise valuations and lower returns for all the other competitive investors.  Mathematically, the median return an investor in public markets can expect must fail to beat a low-cost index, after expenses, because the individual investor is competing with all the other investors.

This is a key reason why the average retail investor consistently earns below-average returns. For the 20 years ending in 2012, the S&P 500 Index averaged 8.21 per cent a year, an attractive return. The average equity fund investor earned a market return of only 4.25 per cent. 

I can only think of a few exceptions to this zero-sum principle.  One are investors in truly new asset classes such as frontiers like the Pakistani stock market, which really does provide new and less-contested opportunities for investors to put capital to work. Another exception are investors who proactively add value to their portfolio companies as ffVC strives to do, thereby, we believe, increasing returns.

Joe Reilly:  According to the NVCA, angels invest as much money in the US as venture capitalists.  Should family offices, who tend to be conservative, consider angel investments an asset class?  And if so, how should they access these investments?

David Teten:  Angel investing is the highest-performing asset class we know, albeit the most illiquid and opaque.  Across a dozen different research studies, we’ve seen median returns of 18% per cent to 54 per cent.

In aggregate, angels are significant investors.  Over the past decade, angels have averaged more than $20 billion annually in the US. That’s a sizeable amount, especially in comparison to the US VC industry, which similarly invests a little over $20 billion annually.  In 2012, 268 thousand angels invested in 67 thousand entrepreneurial ventures, according to the 2012 Angel Market Analysis released by the Center for Venture Research at the University of New Hampshire.

However, those angels constitute only about 5 per cent of the estimated 5.1 million households in the US with a net worth of $1 million or more.  I’d argue that many more investors should consider angel investing.  First, because of the returns.  But second, almost all other asset classes are passive: you put your money in and take your odds.  In angel investing, a proactive approach will directly increase your returns.  At Harvard Business School Alumni Angels of Greater New York, we have put a lot of energy into educating our community about the returns potential and process of angel investing.

Most retail investors/family offices under allocate to this asset class.  Two main reasons for this: no one is making fees on their angel investments, so the traditional wealth management industry has no incentive to publicize the opportunity to invest as an angel.  And of course, this asset class is more labor intensive than most others.

Of course, you should not become an angel investor without doing your background reading, joining an angel group, and generally moving slowly.  As always, anyone who tells you about a get-rich-fast investment opportunity is probably a reason to run away fast.

In the long run, most asset classes correlate with the rate of GDP growth, and we do not anticipate that the economy will grow very rapidly over the next decade.  We are extremely fortunate to finance the growth side of the creative destruction we are witnessing all around us.  We hope that more individual investors will join us as angels.