The 99: How the SEC protects you from venture capital returns.

I don’t need to remind you of the widening gap between the rich and the poor, but if I were to be more accurate, I’d say it’s the widening gap between the mega rich and everyone else.  When you’ve already got tens and hundreds of millions of dollars, a whole world of moneymaking opportunities are available to you that the rest of the world can’t access.

Take venture capital, for example.  

To benefit from the explosive growth of companies like Uber, Airbnb, Dropbox, etc, you had to fit in either one of two categories: be an angel investor already in an inner circle of experienced angels and entrepreneurs, largely located in Silicon Valley, or be an investor in a venture capital fund that backed those companies.

Very few are ever going to wind up in the former category–so the most accessible option for most investors would have to be a capital fund.  Only, that’s not such an accessible option as it turns out either.

The SEC, in an effort to “protect the little guy” has all sorts of regulations.  First, you have to be an accredited investor–someone with a few hundred grand in income or a million to your name.  Below that and they need to keep you from investing in really risky stuff, like venture capital.  

Of course, they don’t prevent you from putting your whole savings into penny stocks, but that’s another story.  

Even just being accredited though doesn’t mean you’re in.  One regulation has effectively kept the most investors from  participating in the most recent tech boom–namely the 99 investor limit in a limited partnership.  That’s how most venture capital funds are structured.  While the “accredited investor” requirements for being allowed into these funds aren’t so onerous , they make it really unattractive for funds to take smaller checks.  

You see, if you’re trying to raise a $50mm fund and keep it to one legal entity, you can only have 99 underlying investors.  Math dictates that they’d have to each commit a little more than half a million dollars to the fund–and that’s if they each only count for one beneficial owner.  Family offices, for example, often have many beneficial owners.  Even if they’re pooled into one fund for investment purposes, each member still hogs up a slot towards that 99.

If you’ve got $5mm net worth, you can fit into another type of fund for “Qualified Purchasers”.  You can have up to 500 of those.  Think about it, though.  If you’ve got a fund full of QPs, why bother accepting the 99 little guys in a dinky sidecar fund?  They won’t add up to much, relatively, speaking.

That makes the fund investor beneficiaries of the Uber ride, for example, from a single digit million dollar seed valuation all the way on up to $80 billion mostly people who already have at least $5mm, family offices that have multi-generational wealth, or college endowments large enough to have venture programs (typically Ivy Leagues).  

In an age where technology enables fund managers to onboard, update, and organize large amounts of investors–why is there a limit at all?  Why can’t my parents put $5k into the next Brooklyn Bridge Ventures fund–a diversified pool of 30 something investments?  These rules wind up making it easier for accredited individuals to make one angel bet, but make it really hard to get into a portfolio of 30 bets.  

In the late 90’s, when dot coms went public, even though the sector didn’t do well as a whole, there were still opportunities to make significant returns as an individual investor.  Public market fans of Google, Apple, Amazon, Yahoo, etc who held on did quite well, while the IPOs of today are leaving little upside for today’s investors.  Companies are staying private at higher and higher valuations for a host of reasons, so if you’re not in a venture capital fund, you’re largely missing out on the tech boom because there isn’t as much upside left anymore once a company goes public.

Because Brooklyn Bridge Ventures manages smaller funds, it can get away with one entity and be fine–even though a few of my family office investors count for multiple underlying beneficiaries.  However, I’ve decided that involving a wider community of investors is beneficial to the founders that I back–and honestly makes for a more interesting experience for me as well.  I value the feedback and insight I get from my Limited Partners and the community we’ve built.

Therefore, in future funds, I’ll be moving my family offices and institutions into their own QP fund to make a bit of extra room for accredited individuals.   Unfortunately, I can’t allow all 10,000 people on my weekly newsletter to toss a grand in, because I’d be thrilled to have it be such a community effort, but happy to speak with investors who are excited about getting access to the NYC innovation community and can commit a couple hundred grand over the next four years.  This, of course, isn’t a solicitation to invest in any specific investment vehicle.  I’m just saying that I’m open to conversations with accredited investors who are supportive of tech entrepreneurs who might not have considered themselves fund investors before because of size constraints.