An early Facebook exec explains why investing in startups without meeting them is the future of venture capital

Brian Ach/GettyChamath Palihapitiya
  • Chamath Palihapitiya is trying to blow up the old-school, biased venture capital industry in every way he can think of.
  • In the past few months he announced two new plans. One is a potentially industry-changing method of investing in startups all over the world, sight unseen.
  • The other is a different way to fund bigger startups that’s like an instant IPO.

Chamath Palihapitiya is living an epic life. He’s a true rags-to-riches Silicon Valley success story. And he’s got a plan to bring that same sort of success to millions of entrepreneurs around the world in a way that’s blind to a person’s sex, race, colour, or nationality.

Palihapitiya is the founder and CEO of VC firm Social Capital, which has backed companies like Box, Slack, SurveyMonkey, Yammer. His new plan involves investing in startups without ever meeting with them.

Palihapitiya is perhaps best known as an early Facebook employee whose Facebook stock left him a wealthy man in his 30s. He’s also known for his stake in the Golden State Warriors basketball team.

Chamath PalihapitiyaBusiness Insider

Palihapitiya was born in Sri Lanka and moved to Canada as a kid, a refugee. His family struggled financially but Palihapitiya has a gift for numbers and an abundance of street smarts. As a kid, he learned to count cards and won his classmates’ quarters during lunchtime card games. He grew those winnings by playing Blackjack at charity gambling events.

Shortly after graduating from college with an engineering degree he landed at AOL. That’s where he met Mark Zuckerberg who hired him to be an early member of his management team.

He’s still a good gambler, known to host one of Silicon Valley’s most popular poker games or take a spin with the World Series of Poker tournament held in Las Vegas.

And all of that makes him comfortable risking money, even his own personal fortune, which is a major part of Social Capital’s investment fund.

Ludicrous and crazy

His plan to invest in startups sight unseen is called capital-as-a-service or CaaS, a play on the name of the cloud-based software (software-as-a-service) that has transformed the tech industry.

When CaaS is eventually released to the public – slated for 2019, he tells us, with beta testing going on now – it will involve software that automatically evaluates a startup’s online fundraising application and approve it, or deny it.

“If you’re only talking about a small amount of money, $US50,000 to $US500,000, why can’t we use our software and a lot of the things we learned over seven years of building companies, why can’t we use that to make a decision?” he asks. “We have learned over time signals that predict company success.”

If you’re only talking about a small amount of money, $US50,000 to $US500,000, why can’t we use our software …

Examples of those signals include the company’s revenue, revenue growth, average revenue per user, lifetime value of customers, total cost of acquisition, total addressable market and so on. The software verifies that the entrepreneurs are being truthful with the numbers by tapping into the cloud apps they use to run their business, such as data stored on Google’s cloud.

Palihapitiya likens the idea to the way banks treat loans. If a wealthy person asks JP Morgan for a multi-million dollar credit line, she’d get the white glove treatment in securing it. If a regular Joe is looking for a credit card, he’d submit a form and a software algorithm that predicts credit worthiness would decide.

Right now the VC industry offers only white-glove treatment and the process is loaded with bias.

“It’s ludicrous the idea that you could only get funding if you found a way to come to Silicon Valley on a Monday through Friday, from the hours of 9 to 5, if you happen to be of a certain gender or age, or etc. That’s crazy,” he said.

If the startup succeeds and needs access to more investment, “a $US15 million or $US20 million check, then we’ll meet with them face to face,” he said.

Eyes wide shut

The CaaS software will allow Social Capital to extend its hours of availability to 24×7 and extend its areas of investment to anyone, everywhere in the world.

Muslim family vacation holidayShutterstock

And the bonus is that CaaS is totally blind to things like gender, race, sexual identity, colour, what have you.

And that has already produced some astounding results.

Women founders received a scant 2% of all VC funding in 2016,according to PitchBook, a database that tracks VC deals. But in the closed first test for CaaS, earlier this year, out of 3,000 companies that applied, Social Capital funded “about 80 companies from 22 countries and 42% were women. And a huge number of them, like 1/3, were profitable,” Palihapitiya said.

“It just goes to show you, there are so many great people doing interesting things all over the world. What is not well distributed is this access [to capital],” he said.

Not only that, but by using blind data, Social Capital is funding ideas he probably wouldn’t have considered.

For instance, he’s now backing a company in Jakarta, Indonesia, that delivers dinner to young working women and their kids, so they could work longer hours.

Palihapitiya said that he’s had hit-and-miss investments in food delivery and wasn’t keen on the market. But the numbers were exceptionally good for this company serving this niche he had never heard of.

Young people smartphones IndonesiaUlet Ifansasti/Getty ImagesYoung people play Pokemon Go game on smartphones in front of a KFC restaurant on July 23, 2016 in Yogyakarta, Indonesia.

Other examples include an affordable medical diagnostic tool in Mexico, an enterprise security platform in Turkey and a Kenyan mobile market research platform.

Palihapitiya hopes that other VCs will follow his lead and invent their own version of CaaS and change the world.

“If we get millions of people to start companies, so many interesting things will get created. So many things we didn’t have any knowledge of will get created. The world gets more stable. There’s probably more peace and prosperity,” he said. “It requires us to close our eyes and be a bit more bias blind.”

He said there are amazing companies all over the world, “Let’s throw a little bit of bread crumbs and tap into it.”

Reinventing the IPO

In addition to inventing a new way to fund startups sight unseen, Palihapitiya is also trying to rejigger the way successful startups make their exits.

He recently completed a $US690 million IPO for a “special purpose acquisition company” [SPAC], a type of corporation also known as a blank-check company.

He’s going to use that money to buy one or more startups which will almost instantly turn them into public-traded companies, taking about 60 days via an acquisition, instead of the 18 month IPO process.

He views this as a new kind of growth stage fund designed to let growth companies keep top employees.

That’s because it will give employees an easier way to sell the stock they are paid as part of their compensation.

He isn’t yet talking about the companies he’s eyeing to be the first beneficiaries of his $US690 million publicly traded fund. But he’s still gung-ho about the method’s long-term prospects.

“We’re in the business of providing funding to entrepreneurs,” Palihapitiya said. “So we should just go and blow up the IPO process.”

Now that you’ve read about Social Capital’s bold plans, take a deep dive into blockchains, the ground-breaking tech that could be as disruptive as the internet.

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