Disrupting the venture capital market?

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Blockchain technology enables a digital and decentralized exchange of information and fiat money between two people who do not know each other. One of the many underlying intentions is to make mediating institutions such as banks replaceable.

Humanity has been gripped by several technological revolutions in recent decades, leading some people, for example Ryan Allis (CEO of HIVE), to describe our time as an “innovation age.” In this innovation age, one of the latest technologies is the bitcoin-based distributed ledger technology (DLT), also known as blockchain technology.

The impact of blockchain and its associated technologies on the venture capital market

Among other things, this technology enables a digital and decentralized exchange of information and fiat money between two people who do not know each other. One of the many underlying intentions is to make mediating institutions such as banks replaceable. The venture capital market is also not unaffected by the DLT-based Security Token Offerings (STO) and Initial Coin Offerings (ICO). Similar to an Initial Public Offering (IPO), a company with an STO or ICO tries to collect money from different investors who receive a token in return for their investment. This token can then be traded on specific exchanges.

The fascinating thing about this is that ICOs had already collected around $5.5bn globally in 2017, even though this form of investment has only existed since 2016. Even though this amount represents only about 3.5% of all conventional early-stage investments in the same period, it shows the direction the current changes in the venture capital market are taking.

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The six biggest pain points of venture capital companies

Blockchain and its associated technologies, such as smart contracts, ICOs, and STOs, have a particularly strong influence on the problems of venture capitalists.

Six key challenges emerge when looking at the venture capital market:

  • The investment process is very costly for venture capital firms in terms of due diligence, which includes notary fees.
  • The long period of bound capital in investments poses a problem for venture capital companies. This problem can currently be solved, for example, by a later exit through an IPO or disinvestment.
  • Some venture capital companies in Germany lack the financial capacity to invest in a large number of startups.
  • A principal-agent problem exists between the investor (VC company) and the startup because the startup has different objectives and more access to information than the venture capitalist. Furthermore, the startup’s intellectual property is vulnerable due to the principal-agent problem and the investor’s intentions.
  • The determination of viability and success of a startup presents VC companies with the so-called sorting problem.
  • Uncertainty about the development of investment opportunities related to blockchain startups is growing among venture capital firms. This is partly due to the success of ICOs and STOs. ICOs offer startups the opportunity to raise money without having to forego equity capital, without having to give investors a place in management, or without initially having to present a monetization plan.

Quo vadis venture capital market?

This incipient impairment will lead to several exciting and unexplored questions. These gaps do not only concern the potential of DLT on the business models of venture capitalists and the market itself, but also how these companies could use the potential for themselves. It is also interesting to find out whether VC firms, which deal with startups as well as the revolution and evolution of other industries on a daily basis, would be better prepared for a revolution in their own market than old-economy players.

Florian Vatter advises clients in transforming and securing their business services as well as model by using future technologies, such as the Blockchain technology. You can contact him at florian.vatter@capgemini.com

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