Startup companies are an essential part of the US economy stimulating economic development by providing job creation, business innovation, and wealth creation potential through appreciation of equity value and operating profits. Unfortunately, investing in these young companies has been traditionally limited to private market funds such as venture capital that has only been available to wealthy individuals and institutions under strict accreditation rules due to their high risk/reward nature and liquidity concerns. This has resulted in the vast majority of US Households being restricted from investing in these opportunities.
For that reason, a recent decision by the SEC brings great news of an innovative investment vehicle in the form of a new 40 Act fund structure that can now offer venture capital investing to all US citizens 18 and older with a minimum investment of $1,000. This new fund fundamentally changes and democratizes who can invest in venture capital and early-stage startup companies.
To learn more, we reached out to Will Zell, Founder & CEO of Zell Capital - a Columbus Ohio based investment company that is launching the first ever ‘Access Fund’ that opens venture capital to all investors. We wanted to understand the thinking and the structure behind the novel investment solution with particular emphasis on learning how Zell Capital created this innovation.
Hortz: What exactly is an Access Fund? How is it different from a typical mutual fund?
Zell: The Access Fund is a closed-end fund registered under the Investment Company Act of 1940, specifically designed to open private market fund investing, such as venture capital, to all investors. It is designed to function as a way for non-accredited investors to have access to these investment opportunities. The Access Fund structure has all the disclosure and reporting requirements that are part of a 40 Act Fund, while enabling fund management to execute investment strategies in private, illiquid markets.
Hortz: How exactly did you work with the SEC to create and achieve effectiveness for this new investment vehicle?
Zell: The 40 Act does not preclude registered funds from investing in private securities. To create a structure that accommodates venture capital investment strategies, however, there are many operational and mechanical issues to work through. With the help of incredible legal counsel, we submitted a N2 registration statement to the SEC in April 2020 presenting this novel structure and spent 13 months in the registration process. At the end of that process, we were able to solve the operational and mechanical issues that allow us to invest in venture capital.
I believe that developing ways to open private market access has been a priority within the SEC for some time given the JOBS Act that enabled equity crowdfunding. I am grateful that we were able to complete the registration process and the fund is now effective without the need to create new legislation or pass rule changes, but rather innovating within the rules that exist.
Hortz: What was your motivation and value proposition behind creating this fund to invest in startup companies?
Zell: I have long held the belief that every investor should have access to private markets. There is a world of investment opportunity in private markets, such as private equity and venture capital, that has traditionally been accessible only to wealthy individuals and institutions, also known as accredited investors. There are risks in private market investing that must be considered and understood by investors, including a lack of liquidity, very long holding periods, and accreditation rules have been an appropriate method for the SEC to mitigate risks investors could face due to a lack of understanding.
However, we are living in a new time. Access to information and content to learn about private market investing is readily available online. Any investor can easily learn about private asset classes and understand the risks. So, there is no reason a non-accredited investor should not be able to invest a small percentage of their portfolio into private markets, similarly, to accredited investors.
Also, fund-based strategies can be ideal for investors. Rather than building an active portfolio, investors in Access Funds can rely on a professional team that deeply understands the asset class and focuses on the investment strategy every day.
Hortz: Can you give us a brief overview of the venture capital marketplace this fund will be accessing?
Zell: Startup companies backed by venture capital investors generally raise capital and are described by the progress they have made:
Pre-seed – an idea on a napkin or a little more, Seed - something (product/app/technology) has been built but there is no proven revenue model and possibly no revenue at all, Series A – the product/app/technology has been proven more in the market, generally demonstrated by revenue growth, Series C, D, E and so on – are considered growth rounds in companies that have proven a successful business and continue to raise investor capital to accelerate growth faster than they can through their own cash flows.
Zell Capital invests in Seed and Series A rounds, where we can purchase equity when a company has a low valuation (generally between $5 and $50 million). While there is always the risk of loss of your investment, I believe that founding and early equity ownership has the potential to be a great tool for wealth creation. It is the stage of startups I have focused on for the last decade and where I am qualified to lead an investment strategy. We also will provide debt and debt-like investments, such as revenue-based financing, to companies in the Series A stage of development, where we expect a rate of return higher than lending to more established companies.
Hortz: What is your investment strategy as to the type and size parameters of early-stage startup companies will you be investing in?
Zell: For Seed financing rounds we will invest between $250,000 and $1,000,000. For Series A rounds we will invest up to $2,000,000. We expect that our initial offering of $50 million will create a portfolio of roughly 25 startup companies that we invest for equity and additional startup companies where we invest in debt or debt-like structures.
We will opportunistically invest in startup companies across the United States. The fund will invest through our thesis based on the First Principle of Value, which is to be applied as a filter to vet startup companies across a variety of industries as we go through our due diligence process.
Hortz: What is your due diligence and investment selection process for these companies? How do you determine positive risk/reward opportunities in the disruption these companies represent?
Zell: Startups are fundamentally a game of displacement. Every startup company has speculative claims about their ability to enter a market and deliver a new offering that is so much better than what exists, that current buyers in the market will leave the existing offering and adopt the new offering provided by the startup. Using our investment thesis of the First Principle of Value, which refers to the general goal of venture stage companies to create a new space in a developing market by creating a new value transaction that displaces the status quo with a novel solution. This goal is often difficult to accomplish, which is why investments in such venture stage companies often involve high levels of risk. During our due diligence process, we seek to first understand the status quo and then assess the startup’s solution based on a cost vs. experience analysis, factoring all of the pain related to a buyer leaving the status quo and choosing the startup’s solution.
Hortz: Are there different aspects to purchasing this fund?
Zell: Yes. Shares of Zell Capital are not traded on an exchange. The investment process is fully digital, and our investor portal is managed by US Bank’s Global Fund Services. During the Initial Offering Period, which is the first 18 months or when we achieve $25 million in assets under management, shares will be sold at a fixed price of $20. After that, shares will be sold at NAV, which will be calculated monthly. We will close the offering at $50 million in order to focus on deploying capital into startup companies.
Hortz: How would you recommend advisors work with and allocate this fund to client portfolios?
Zell: Generally, accredited investors and institutions active in private markets will allocate a small percentage of their portfolio into these asset classes, say 2%-10%. It is reasonable to assume that a similar allocation strategy would make sense for non-accredited investors. It is important for advisors to understand risks related to private markets, such as the lack of liquidity and long investment horizons. Advisors should consult with their clients to determine the most appropriate strategy.
Hortz: Any other thoughts or recommendations you would like to share with our readers?
Zell: I believe private market funds will be a new frontier for advisors and their clients. Our goal is to build long term relationships with the advisor community where we can be an ongoing resource for advisors and their clients with risk-appropriate access to this new world for them.
We are readily available to meet with advisors and share more about Zell Capital, the private investment markets, and the Access Fund structure. To understand startup investing more, here is an infographic created about the asset class – Why Startups?.