There’s little question that former Facebook executive and venture capitalist Chamath Palihapitiya thoroughly enjoys challenging the way that startups are funded. Because he has the hot hand, so to speak, he’s able to get away with it, too.
Last month, for example, Palihapitiya’s firm, Social Capital, took the unusual step of raising $600 million in an IPO for a SPAC called Social Capital Hedosophia. The shell company will use the money to acquire all or part of a privately held tech company, thereby taking it public and circumventing what Palihapitiya sees as the unnecessarily long, expensive and distracting process of going public.
Now, Social Capital has another trick up its sleeve. It’s beginning to invest in far-flung startups, sight unseen.
How it works: entrepreneurs from anywhere in the world can fill out a questionnaire, then submit revenue figures and either raw engagement or transaction logs (or both) to Social Capital, including sometimes by granting the firm direct access to the cloud services they use. It’s entirely self-serve. If Social Capital likes what it’s sees, it will write a check of up to $250,000. If it doesn’t, it will at least deliver feedback to the startup regarding tweaks it might make to its business model. (
How can Social Capital possibly know how to improve a company’s business model when it hasn’t even met its founders? Palihapitiya and Ashley Carroll, the firm partner who oversees the program — dubbed “capital-as-a-service” — explain that Social Capital has already built up an enormous database of information over time with the help of its more traditional venture portfolio companies.
Its own internal platform team — mthis information to help the firm’s companies figure out their growth strategies. Now Social Capital is simply using this same platform to find and fuel companies in harder-to-reach places.
“VC has always been this high-touch, in-your-face-type business,” says Palihapitiya, “When the talent was concentrated in Silicon Valley, that worked. But a negative byproduct [of that way of doing business] is that for every business that got funded, [other worthy startups did not] because of biases that didn’t pattern match.”
Now, adds Palihapitiya, “We can run A/B tests. We can say, here’s how we think about cohorts, or here’s how you optimize how you spend money on Google and Facebook. This data is [precious]. If a company can tell us how it’s doing, we know how to help them, and how they look relative to all the other companies we’ve ever seen. Now, we can see a business in Africa or South America or Southeast Asia . . . and algorithmically fund them at hyperspeed.”
Makarov has an undergraduate and business degree from Harvard. She has worked for Bain Capital. She has worked as an investor. She cofounded and was CEO of Carmudi, one of Latin America’s biggest auto classifieds sites. As a result, she says that raising an initial $640,000 from local investors for Apli wasn’t terribly challenging.
Things got tougher when the company started seeking out a Series A round, however
“Mexico has made a lot of progress in the last four years,” says Makarov. “We have some very good local funds funding innovative Mexican companies. But the fund sizes are still small, and their numbers are limited. Even with Silicon Valley connections,” which Makarov says she has, “if you’re based in an emerging market, forget about [attracting attention from Silicon Valley venture firms].”
Makarov calls her experience with Social Capital “very refreshing” in contrast. “It literally took a phone call, then they asked me to upload a questionnaire and data so they could look at our traction. I didn’t have to fly to San Francisco to meet them. It took less than a month from [the call] to receiving money in the bank.” Specifically, she says, Social Capital participated in a $1.5 million seed round, providing the company with a convertible note.
She adds that she sees the firm’s participation as a “stepping stone” to Silicon Valley. Her understanding is that the firm will “continue receiving data from Apli and watching our evolution, and they’ll be contenders to lead our Series A” in exchange for its help.
Unsurprisingly, Social Capital’s plan has skeptics. Among them is Ian Sigalow, a New York-bsaed partner and cofounder of Greycroft Partners, who doesn’t put too much stock in sheer data analytics.
Greycroft maintains its own database, including startup ratings created by its partners that address a spectrum of factors. “When we look at our own data here,” Sigalow says, “the most successful outcomes we’ve seen are correlated to the people we meet and their presentations.”
Early-stage investing is “really betting on people,” he adds. “People have tried to build an algorithm that [trumps this], but none exists that can replace the degree of pattern recognition involved. It defies putting a bunch of data into a computer and running a regression on it.”
It isn’t clear that Palihapitiya’s cofounders at Social Capital approve of Palihapitiya’s thinking, either. Co-founder Mamoon Hamid left last month to join Kleiner Perkins Caufield & Byers. A third co-founder, Ted Maidenberg, also plans to leave the firm before it raises its next fund.
There’ve also been grumblings by some of the firm’s investors, who worry that Palihapitiya may just innovate his way into trouble.
Palihapitiya downplays any strife, noting that the “overwhelming majority” of the capital the Social Capital has raised to date “comes from myself and four other people, and all of us are pretty happy with returns to date, which are exceptional.”
Social Capital, which is just six years old, now manages more than $2.5 billion worth of assets and has reportedly deployed two-thirds of its third, $600 million, early-stage fund, which it closed in 2015. Because of its age, many of its companies remain in “scale mode,” says the firm, though its exits include the enterprise companies Yammer, sold to Microsoft for $1.2 billion in 2012, and Box, which went public in 2015.
“What you saw, to be blunt and honest,” continues Palihapitiya, “was the migration of very traditional LPs that we admitted, and as much as their realization about how this industry need to change, them going through the seven stages of grief concerning the traditional model breaking, which has to do with a bunch of historical decisions they’ve made.
“Where the [investing world is going, where every industry is going, is [pairing] humans with software and tools to do the job better. It’s how you do surgery. It’s how you do loans. It’s how you detect cancer. And it’s probably how you do VC going forward, too.”
Skeptics and supporters
Certainly, Social Capital has some support by VCs who also see the winds changing. Among them is Matt Turck, a managing director at FirstMark Capital in New York, who has long been intrigued by data-driven venture firms.
The way he sees it, the “venture capital model is under assault from different angles, and there are enough questions around it and the way the world is evolving that it’s worth thinking through it and trying different things.”
Turck thinks Silicon Valley especially needs to start thinking differently, and fast. The way he sees it, there’s a “tremendous amount of money in the system, making everything incredibly expensive, from salaries to the cost of living. Companies like Google are being increasingly aggressive around all the different areas that people see as impacting the future, like artificial intelligence.” That makes it hard to grow a small AI business into a big independent company.
Another trend that’s “super interesting if fairly obvious by now,” says Turck, is the globalization of entrepreneurship.
“It’s less and less clear to me where the next wave of unicorns will come from,” he says. “Indonesia? Eastern Europe? South America? To capture the one that comes out of a random place isn’t so easy. I think the concept of creating a broad network globally, with this global contributory database of information, is really very smart.”