Dry Goods: Nine Difficulties for Web 2 Institutional Investors to Enter the Web3 World

Solana was my first token investment and it wasn’t easy to do.

Back in 2018, when I first met Solana co-founder Anatoly Yakovenko, my fund at the time, 500 Mobile Collective, was not legally allowed to invest in digital assets. To support Yakovenko’s firm (then called Loom), I had to get two-thirds of the limited partners to agree to amend the fund’s LP agreement. I wonder, am I too far down the rabbit hole? Am I taking too much risk for the fund? Or is Web 2.0 so different from Web3 that my LP can’t understand it?

Fast forward to four years later – all the trouble was worth it. Solana has become one of my most successful investments, generating 4,000x returns. However, what I now consider normal — dealing with pseudonyms, betting on founders on the other side of the world who don’t want to give investors any control — still confuses my colleagues who emerged during the Web 2.0 boom.

With a total market cap of $1.7 trillion and more than $30 billion in venture capital pouring into the space in 2021, cryptocurrency is an industry that no investor can afford to ignore. However, even though some big companies like Sequoia, a16z and more recently Bain Capital are building their crypto businesses, many smaller companies are still entering the Web3 world unprepared.

A bunch of big companies can’t sustain an industry on their own. More quality investors backing founders equals a stronger crypto ecosystem. So it’s time to take a step back and reflect on what I’ve learned from the experience — and more importantly, open doors for new investors in the Web3 world.

Investing in a Web3 company requires rethinking the investment model from the top down, from how allocations are made to LPs all the way to how funds are set up.

1. Investing in Web3 projects can be legally tricky

Venture capital firms can only invest up to 20% of their funds in liquid assets—a number beyond that, and the SEC says you must be a registered investment advisor. If you include the salary of the compliance officer you need to hire, the process can take up to 12 months and cost around $500,000.

For Sequoia or a16z, this might not be a big deal, but if you’re running a $10 million fund, the cost of being an RIA will exceed your annual management fee. Another option is to set up a hedge fund centered around token trading, which brings with it a series of additional fund management requirements.

2. Control in Web3 is a very vague concept

The Web3 founders do everything in their power to make sure their community feels like they own the project — not the investors, or even the founders themselves. Most venture funds require at least 10% ownership in their portfolio companies, but the Web3 founders don’t want any single investor to own more than 5%. This distributed ethos extends to the Web3 governance structure. Web 2.0 companies will have a board of directors, and a decentralized autonomous organization will allow anyone with a stake in the company to vote in its decisions, weighted according to the size of the stake. The collective may decide to move in a direction that you as an investor never thought of or would never approve. The founders you initially support may lose control over the direction of the project, but you must be able to go with the flow.

3. Crypto founders don’t want to show their faces or even use their real names

Protecting pseudonyms is a core part of crypto culture, but it’s also unsettling Web 2.0 investors. Founders may want to hide their true identities for a variety of reasons, from not wanting to be judged based on their gender, ethnicity, work or school background to wanting to minimize potential legal and personal safety risks.

4. Lawyers don’t understand Web3

Web3 terms are not simple agreements for future equity, but simple agreements for future tokens, or sometimes SAFE plus warrants that entitle investors to discounts in future funding rounds (more on these later). These concepts are so new that most legal advisors aren’t sure what to do with them. Finding those — or at least willing to keep an open mind during a legal review — is always a challenge.

5. No Prorated Rights

Most Web 2.0 investors are fighting for pro-rata rights to ensure they can participate in future funding rounds and maintain their ownership in the company. In the Web3 world, this concept does not exist. Why? Because raising more money doesn’t mean issuing more tokens. If I buy 5% of the tokens of a crypto startup early on, no matter how much money the company raises, I still own 5%. As a result, larger funds end up investing in the public market or buying tokens from corporate coffers — for example, a16z invested in Solana in June 2021, more than a year after its public listing.

6. Web3 investors have a completely different exit strategy

Young companies that achieve a certain level of revenue, growth and valuation often seek to graduate from startup status by going public, whether through an IPO, direct listing, or special purpose acquisition of the company. If they were in the U.S., they might opt ​​for a Nasdaq or NYSE listing. In Asia, they would choose the Hong Kong Stock Exchange, etc.

Again, this concept does not exist in the Web3 world. Most token projects are listed on centralized exchanges like FTX or Coinbase, or directly on decentralized exchanges like Uniswap or Serum. There are no specific growth or valuation requirements for listing, nor is there a limit to where or how many exchanges you can list your token on. 

7. Web3 companies go public much faster…

A seed valuation of $30 million is quite high for a Web 2.0 company. You can even call it expensive. In Web3, a seed round of $10 million to $70 million is reasonable. Most investors are willing to accept such a large number because listing on a cryptocurrency exchange is much shorter than listing on a stock exchange, which provides investors with faster liquidity and exits. For example, we invested in FTX in July 2019 and its token went public less than two months later. (Yes, we still hold these tokens.) 

8. …but the lock-in period is much longer

It can take 10 years or more for a successful Web 2.0 startup to go public. In Web3, it’s not surprising that a project goes to market within a few months – Solana, for example, took about 16 months, and longer. On the other hand, standard stock IPO lock-ups are typically 90 to 180 days, while Web3 tokens have a lock-up period of at least one year, and sometimes as long as three years.

9. The distribution mechanism is completely different

In the case of a Web 2.0 liquidity event, venture fund managers may choose to allocate cash or stock to their LPs. The Web3 fund manager wants to distribute tokens. These may have greater advantages over Web 2.0 releases, as Web3 projects sometimes take months or even years to gain real community adoption and drive.

Unfortunately, most LPs aren’t set up to handle tokens – they don’t know what a crypto wallet is and don’t want to bother figuring it out. It took about 9 months for one of my LPs to finally open an account on a cryptocurrency exchange to accept tokens from my Solana investment. Since then, the tokens have increased in value by roughly 700%, making all the hassle worthless.

The Web3 world is exciting, but it does shatter a lot of the orthodoxy we’ve come to expect in venture capital. However, I truly believe that great founders still need patient investors to support them and support them through the coming crypto winter. The best Web 2.0 VC ethos is still related to Web3, but that’s far from copy-pasting what we know.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/dry-goods-nine-difficulties-for-web-2-institutional-investors-to-enter-the-web3-world/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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