Part I: Why we want to build a systematic investing strategy
Part II: The operational hurdle of valuing companies at scale
Part III: Other investors in the ecosystem
Part IV: How systematic investing will help entrepreneurs
Part V: Getting the deal done – from outreach to close
Since CircleUp was founded, our mission has been unwavering: to help entrepreneurs thrive by giving them the capital and resources they need. We use Helio, our machine learning platform, to help advance that mission. By pushing down search costs through automation, we’ve been able to find companies more quickly and build conviction earlier than ever before. In doing so we’ve supported hundreds of entrepreneurs as they build their businesses. The long-term result, we believe, will be a more efficient market for the millions of entrepreneurs trying to build their visions for the future.
As our investment and credit teams leverage Helio in their daily work, our data and engineering teams are working towards an even more transformational future of investing. A future where founders anywhere can raise a round in a fraction of the time that it currently takes. A future where it becomes economical to invest in a basket of 100, 200, or even 500 early-stage companies. A future where co-investors can benefit from the signal that comes from objective, predictive, and prescriptive insights. And, most importantly, a future where private capital markets are finally fair.
To make this future a reality, we are embarking on an initiative to use Helio to make investment decisions with minimal human intervention. By investing in a rules-based or “systematic” fashion, we believe we will be able to serve founders more efficiently and deliver value to a larger number of companies than ever possible.
The public equity markets have seen an exponential rise in algorithmic investing over the last decade. According to a JP Morgan Report it is estimated only 10% of investors are actually manually picking stocks and that 60% of trading volume is purely systematic or quantitative in nature. Fund managers like Renaissance Technologies, AQR and Two-Sigma have become extremely successful by relying on algorithmic trading as a core facet of their investment philosophies, and today, BlackRock, the world’s largest asset manager, has systematic strategies that co-exist with traditional manager-controlled funds.
To achieve a future where we serve founders more efficiently and effectively, CircleUp is applying the innovations of systematic investing in the public markets to the private markets. It’s a daunting and ambitious task, but we believe that we have the inputs to make revolutionizing private investing possible.
To be clear, we aren’t ignoring the fact that investing in the public markets is extremely different from investing in the private markets. First, in the public markets, there is pricing data on how much a company is worth every day (every second even) which just doesn’t exist in the private markets. Second, there is minimal, if any, friction in investing in the public markets, while the friction of making an investment in the private markets can be significant (companies may not be raising and term sheets require negotiation among other things). Finally, public markets benefit from liquidity, the ability to turn a holding into cash, whereas in the private markets all holds are long.
These three differences are just a few of the obstacles that exist in carrying systematic strategies from the public markets into the private markets. Questions like how to construct an optimized portfolio, how to create systems to invest quickly and reduce friction for entrepreneurs, and how to collaborate with co-investors are all important and extremely complex. Over the coming months, my colleagues and I will be sharing our perspectives on these questions and others, and how we think Helio will help us overcome them. Before we dig into these more technical questions, I want to first answer the question of why we think systematic investing matters at all. The answer resides in two important benefits that systematic investing brings to the table: efficiency and scalability.
Today, raising an equity round is an asset-intensive undertaking for both the entrepreneur and the investor. It’s estimated that it takes 60-90 days for a fast-growing business to close a round and much longer for the majority of businesses. For a founder, those 60-90 days (or 960-1,440 waking hours for those of you who get eight hours of sleep) could be used in dozens of other ways, the most important of which actually involve running a business. Conversely, investors spend hundreds of hours sourcing, performing initial due-diligence, diving into secondary due-diligence, negotiating terms, and presenting deals to investment committee. The process is laborious to say the least.
With a rules-based approach, systematic investors can arrive at a level of conviction quickly. Using Helio, we are able to forecast growth and potential of businesses in an automated fashion. With a rules-based foundation, a systematic investing strategy built on Helio will be able to combine the sourcing and due-diligence processes that take investors weeks into a matter of seconds. As mentioned earlier, we’re not naive to the realities that make private investing more time consuming. However, going from first meeting to closing in 15 days or less is a massive improvement from the status quo.
Related to, but fundamentally different from the role efficiency plays is the value that stems from the scalability of a systematic investing strategy. Scalability benefits a number of stakeholders: investors, limited partners (LPs), and founders.
For founders, efficiency and scalability go hand-in-hand. Because raising equity has historically been a months-long exercise, many founders think of raising money as something they need to do extremely intentionally. The result is that most founders aren’t actively raising and won’t take on equity unless they are in the midst of an open fundraise. Systematic investing can change that perception entirely.
For investors, systematic investing unlocks an entire asset class and mitigates a number of risks that most LPs have to think about. First is scale-up risk. As most private equity funds grow, they start to focus on later-stage businesses to keep their economic model constant. If one investor can only diligence one deal, then she would need to write a larger check if she has a larger pool of capital to deploy. As a result a firm that begins with a $50M fund will look at very different deals when it raises a $500M fund. With systematic investing (especially in CPG), that dynamic is not an issue — the entire sector is blue ocean, meaning an investor could easily deploy $500 million, or even a few billion dollars into this asset without creeping into larger companies. This allows investors to stay focused on the same size deals, where the investor has the most expertise. Second, is key-person risk. The best VCs pride themselves on their network or brand. That network or brand is often consolidated to one or two key partners. With a systematic strategy, key person risk becomes a thing of the past. The platform must have value to founders, but the risk of losing a “rainmaker” in a fund is no longer present.
By altering the paradigm of fundraising so it becomes less of a burden for founders, the number of founders actively seeking funding will only grow. Coupled with the massive growth of startups in consumer, the demand for capital will also grow. While this rising tide will raise all ships, the expectation from founders will be to be able to raise quickly. Only a systematic strategy can effectively deliver on a promise to do so.
The Path Forward: A Product That Benefits the Entire Ecosystem
We believe that systematic investing has the potential to accelerate our goal of getting more great consumer companies the capital they need to grow and be successful. Our systematic strategy will help us support entrepreneurs more efficiently and allow us to work with more companies than we have ever been able to in the past. The strategy also presents a powerful complement to co-investors and provides LPs an asset that has historically been extremely difficult to access. In future posts we will write more on these and other topics, so stay tuned as we take these exciting next steps towards a new future of private investing.