Using Token Economies to De-Risk Venture Capital Investing for LPs

Venture capital is a high-risk high-reward game.

The vast majority of a fund’s return will typically be generated by several companies in a portfolio of 100 investments. And the vast majority of companies will go to zero, be sold for parts, or become also-rans.

But with the S&P500 offering a predictable but modest 10.5% average return, investors who want to see their money work harder turn to venture funds where the typical annual return sought is 20% or more. Most venture funds aim to generate a 3X return on funds invested after 7 to 10 years.

Whether they do or not is another story, and in the current climate of soaring inflation, fiscal tightening, and economic recession, startup valuations are being marked down, and with them, the projected returns of numerous venture funds. This is especially true for growth funds that invest late in a startup’s lifecycle, nearing liquidity events such as an IPO or a high-profile private sale.

Token Incentives and Venture Capital

Recently, a16z general partner, Chris Dixon, wrote about how web3 startups can use token incentives as a go-to-market strategy to bootstrap their growth (as opposed to spending big on marketing and advertising).

Source: Chris Dixon, a16z

For example, early users, supporters, and contributors could be rewarded with the native tokens of a given network, and over time, benefit from the appreciation in the value of that token (which is essentially like owning a share in a company), as well as earn income through staking, or get airdropped additional tokens for their loyalty.

Metaverse and gaming platform The Sandbox has done this on several occasions, and more recently, layer-2 blockchain network Optimism announced it would be distributing its soon-to-be-minted native token to early adopters or users of its network.

Token economies do indeed offer us new and novel ways to incentivize engagement, raise capital, and coordinate resources, and in a tight-fisted economic environment, they can also play a role in de-risking venture capital.

That’s something we’re working on at METARISE — a web3 venture fund and tokenized incubator DAO.

We’ve been running web3 accelerator and startup development programs since 2017 at Collective Campus. The total valuation of our 90 alumni startups has increased by about 3X since program admission, with one startup nearing unicorn status.

We’re now turning our attention to web3 with METARISE, backed by a large and growing list of coaches, mentors, and advisors from platforms such as The Sandbox, Dapper Labs, MintGate, Animoca Brands, Enjin, Lympo, GlobalCoinResearch, Krause House, and more.

How We’re Using Token Incentives to De-risk VC Investing

Every startup that participates in our incubator programs will be asked to pledge 2% of their native tokens in exchange for the education, mentorship and coaching, and access to networks provided.

Based on past experience, we are aiming to incubate about 200 startups over five years.

Now, if the average value of an alum after five years is US$10M (assuming a mixed bag of results from zero to the moon), that’s a total alumni portfolio value of US$2 billion, of which 2% or $40M worth would be sitting in our startup token pool.

These numbers also reflect the total value of the actual startups we’ve incubated since 2017.

How it works

Every limited partner who commits more than $500K to our venture fund will also receive 0.5% of our native $METARISE tokens, with an extra 0.1% for every additional $100K invested. This holding determines the LP’s commensurate share of the above-mentioned startup pool.

So an investor who commits $1 million to our fund would get 1% of distributions from our startup token pool, and as such, $400K of the $40M.

Most importantly perhaps, participating startups also win. Not only do they get ushered through a program designed to get them from zero to one fast, but they also get $METARISE tokens, and exposure to all of our alumni with it, somewhat de-risking the arduous startup journey.

The $2 billion portfolio value assumed is also a relatively modest one for 200 startups. With a portfolio this size, probability suggests that there are likely to be 2–4 home runs that might be worth several hundred million, if not over a billion, each. This is an especially pertinent point when you consider that Series A valuations for web3 startups have typically been in the $50 to $100 million range. As such, it is not unreasonable to suggest that the distribution back to LPs could also be several factors greater than the $400K.

Not bad when you consider that we haven’t even started deploying a single dollar of the $1 million committed to our fund, yet.

This distribution is completely separate from the upside generated from direct investments our venture fund makes in select high-potential incubator alumni and external opportunities.

A bonus incentive offered to LPs, by way of holding our native tokens, is a share in accelerator profits and income from staked tokens.

Finally, unlike investing in a venture fund where one’s commitment is typically locked up for 7 to 10 years, this gives LPs an avenue to generate some liquidity earlier in the piece, especially given that our native tokens will be subject to just a three-year lockup.

We will no doubt see numerous variations and applications of token incentives in the years to come, but organizations that incorporate well-designed token incentives into their business model have a serious advantage.

If you’d like to learn more about METARISE, find us online, review our draft tokenomics here, or shoot me a DM on Twitter.