In the past, finance and venture capital was viewed as the preserve of elitist Wall Street and Silicon Valley types. Ordinary people felt alienated by the lack of accessibility, endless jargon and supposed complexity. These days, however, the landscape is vastly different — and much of that can be attributed to the freight train of innovation that is crypto.
Web3 has opened up global markets to investment, and Australia and New Zealand have been at the forefront of this unstoppable trend. Attracting investment from across the globe, Australia has witnessed the rise of its own crypto unicorns — private companies valued in excess of $1 billion. This includes the likes of NFT gaming company Immutable, NFT trading platform Magic Eden and Synthetix, a crypto asset-backed network that enables the creation of on-chain synthetic assets. Several of these founders are now listed on Australia’s Young Rich List and chances are that we’ll see more in the years to come.
Venture capital has underpinned the growth of virtually all of Australia’s crypto unicorns. Coupled with increased regulatory certainty, it’s likely that Web3 venture capital will continue to proliferate. What then is the world of venture capital all about? Let’s dive in.
What is venture capital and how does it work?
In its simplest form, venture capital (VC) describes investing in early-stage private companies or startups that have either demonstrated high growth or otherwise have the potential to do so. In exchange, investors receive an ownership stake in the business, with the intention that at some stage in the future, they will be able to exit by selling their stake and realise significant profits on their investment.
On the whole, companies that receive VC investment are those unable to raise money in any other way, such as borrowing a sum of money at a given interest rate (known as debt finance). Borrowing money is usually preferable, but most lenders will simply not lend to startups. This is how the company typically ends up considering a VC deal. Naturally, this makes VC both inherently risky, but also carries with it the possibility of incredible returns.
VCs: Things in common
VC firms all have different focuses and strategies, but there are some common denominators throughout. Most often, they raise money from other financial institutions, investment banks and high-net worth individuals who are looking for exposure to higher-risk, higher-return investments. While these investments vary in duration, anywhere from two years to a couple decades, the ultimate goal is the same: exit liquidity — the opportunity to offload the ownership stake for a sizeable profit. Sometimes the exit occurs when the company goes public (an initial public offering or IPO); at other times, however, it’s simply when someone else comes along with an attractive offer.
Confusingly, there are also different types of VC depending on when the investment is made. Seed or startup capital refers to the initial investment. Later investment rounds, or ‘series’ as they are sometimes known, are categorised A, B, C, etc. or ‘early stage’/‘late stage’, depending where in the cycle the investment takes place.
Often, a group of VC firms will join forces in an investment, with one leading the round. This typically means that it sets the terms of the deal, and invests first and, most importantly, the most capital.
To further complicate things, VC firms are not the same as VC funds. A venture capital firm is the perpetual legal entity (such as a company or partnership) under which many individual VC funds can be raised and closed over time.
Given the speculative nature of many venture capital investments and the inherent risk of capital loss, most venture funds are reserved for two classes of investors:
- ‘Wholesale’ investors: generally other institutional investors
- ‘Accredited’ or ‘sophisticated’ individuals: high-net worth individuals who meet a means and income test, which varies around the world.
Unfortunately for ordinary or ‘retail’ investors, most venture funds are not available to them. However, increased demand from the public has led to numerous venture firms creating retail venture funds designed to give everyday investors the opportunity to get in on early-stage companies.
How do venture capitalists make money?
VC firms make money through an ongoing management fee and the ‘carry’ or ‘carried interest’.
Investors who pooled their capital with the VC firm are usually charged a management fee in the order of 2% per annum. At a later stage, when the VC firm exits the investment, it is entitled to the carry or carried interest, which is a percentage of the total investment gains, usually between 20% and 30%.
Understanding venture capital funds in Web3
Venture capital is big business, so one would expect that despite Web3’s rapid ascent, it would represent just a trivial share of total VC investment. Not so.
In True Bridge Capital’s State of VC 2021 report, it found that around US$222.7 billion was raised in total. Contrast that finding with Galaxy Digital’s report which established that in 2021, more than US$33 billion was raised towards blockchain or crypto startups, more than all prior years combined. Thus far in 2022, despite a crypto winter of epic proportions, crypto VCs continue to pour money into the sector to the tune of around US$18 billion.
Recent reports also suggest that many traditional VC firms have started shifting away from technology and artificial intelligence investments and are now leaning towards Web3, since the crypto economy is likely to be the ‘fastest horse in the race’ over the next decade. There’s also growing evidence that the traditional dynamic between venture capitalists and founders is changing — for example, it’s no longer becoming a prerequisite to have a seat on the board of directors.
Web3 becomes the sector of most interest for VCs
The accelerating pace of crypto investment is undeniable. What is it about the sector that is enticing VC firms to gain exposure?
In two words: outsized returns. Frankly, there are few alternatives that offer returns comparable to that of Web3, particularly if the VC fund concerned got in early on a presale prior to the general public. To illustrate, some venture capitalist firms behind Solana got in for 80 cents and watched it get as high as US$260 at one stage. The other attractive feature for venture capitalists is liquidity. Most VC investments are not liquid, meaning they cannot readily be sold at any time. — not so in crypto, which is liquid and tradeable 24/7.
Who are the best crypto VC investors to know?
Other than persuading people to give you money to invest on their behalf (and the odd legal issue), there aren’t many barriers to becoming a crypto venture capitalist. There are therefore thousands of Web3 VC firms all over the world. However, like any industry, there are clear heavyweights who have the most skills, knowledge, expertise, contacts, resources and reputation to gain access to the best opportunities.
Some of the most well-known and established VC firms in the crypto ecosystem are Andreessen Horowitz (a16z), Digital Currency Group, Coinbase Ventures and Binance Labs.
And among the top crypto VC funds are Paradigm, Pantera, Draper VC, Polychain Capital and Animoca Brands.
Australian & NZ VC firms in Web3
The Australia and New Zealand region is rapidly developing a reputation for having some of the most forward-thinking and progressive jurisdictions, underpinned by growing levels of regulatory certainty and strong consumer protection.
Numerous specialist VC firms have emerged in recent years, each with a specific focus, whether it be on the Web3 companies or the underlying digital assets themselves. Below is an overview of some of the more prominent names in the space:
Apollo Capital: fund manager whose flagship Apollo Capital Fund is an award-winning multi-strategy fund investing in crypto assets underlying financial infrastructure of the future.
Airtree: Sydney-based venture capital firm “backing the most ambitious Australian and New Zealand founders building the iconic technology companies of tomorrow”.
Blackbird: Australia and New Zealand-based venture capital firm that backs “generational ambition with generational ownership” across multiple sectors, including technology and Web3.
GD1 | Global From Day One: venture capital firm out of New Zealand backing global companies in technology and Web3.
King River Capital: international venture capital firm with offices in Sydney that invests in high-growth Web3 companies and digital assets.
Aussie Capital: venture capital firm based in Sydney that invests in early-stage companies and protocols “building the next wave of innovations in the digital space”.
Reinventure: diversified Australian venture capital firm with strategic investment in select Web3 companies, including Immutable.
PAC Capital: independent investment manager based out of Sydney that offers private funds with exposure to Web3 companies and digital assets.
Why is VC funding in Web3 important?
There are plenty of reasons why VC funding is important in general, all of which apply equally to Web3.
For starters, it fosters and promotes entrepreneurship, allowing innovators to experiment and test the commercial viability of a project or business idea. In the absence of capital, few of the world’s most influential companies would exist as we know them today.
Aside from simply providing capital, venture capitalists also offer Web3 businesses valuable guidance, expertise, publicity and networks that cumulatively serve to optimise the project’s prospects of success. As a result, these businesses are enabled to scale and grow quickly, creating numerous employment opportunities in the process.
How risky is making a Web3 VC investment?
In relative terms, VC investment is significantly more risky than traditional investments. Unlike investing in a share market (such as the ASX) where companies are well-established, VC investment involves early-stage companies, many of which are yet to demonstrate a product market fit or even a viable revenue model.
Given that the sector is still at such an early stage of its evolution, it is unsurprising that the risk of failure among Web3 companies is significant. However for those that do succeed, the returns can be stratospheric.
In the end, it’s a question of risk and reward. Web3 VC investment necessarily entails a significant amount of risk, but has the benefit of potentially explosive rewards. The trick for VC firms or VC funds is to identify an asymmetry between risk and reward — therein lies the art of making strategic investments.
What is the difference between venture capital and private equity?
Technically, VC is in fact a form of private equity. The primary distinction between private equity and VC is that private equity investors prefer established, stable companies over a venture capitalist’s focus on early-stage businesses.
It comes down to a question of risk appetite. Early-stage companies are inherently more risky than mature companies. And VCs have a much higher risk appetite than private equity investors, all else being equal.
Venture capital is just getting started
It’s clear that the momentum of Web3 VC investment is fast becoming an unstoppable force of nature that is only likely to accelerate. As Web3 shifts the way that communities build, interact, collaborate and congregate, it’s likely that we are yet to see the platforms and networks that will reshape our world.
In the interim, we will see projects rise and fall as the process of creative destruction takes hold. Venture capitalists are making their bets on Web3, and for us ordinary folks on the sidelines, it will be fascinating to see what emerges as transformative, and what turns out to be all hype and zero substance.