Social Capital has started investing in startups, sight unseen

Connie Loizos
There's little question that former Facebook executive and venture capitalist Chamath Palihapitiya thoroughly enjoys challenging the way that startups are funded.

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. (Entrepreneurs interested in applying can let the firm know here.)

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.

An internal platform team -- members of of which came from the Facebook Growth team, including Ray Ko, who reported to Palihapitiya at Facebook, and Jonathan Hsu, Social Capital's head of data science, who started the data science practice at Facebook -- uses this same information to help these companies figure out their growth strategies. Now Social Capital is using this same platform to find and fuel companies in harder-to-reach places.

"VC has always been this high-touch, person, in-your-face-type business," says Palihapitiya, "and 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 AB 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."

Certainly the founders it has funded through the program think it's a great initiative. One of them is Vera Makarov, the cofounder of Apli, a 42-person, 15-month-old, Mexico City-based startup that aims to connect workers with flexible job opportunities.

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 biggest auto classifieds sites. As a result, she says 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 like Mexico, 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 that point to receiving money in the bank."

Specifically, she says, Social Capital participated in a $1.5 million seed round that would have been harder to assemble without its brand involvement. She adds that she sees the firm's involvement -- it gave Apli a convertible note -- as a "stepping stone" to Silicon Valley. "This isn't just about one point in time but how we compare with similar companies in the U.S. and in other geographies over time" says Makarov. 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 founders at Social Capital approved of so much experiementation, 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 well innovate his way into trouble.

Palihapitiya downplays any trouble, 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 now manages $1.8 billion worth of assets and has reportedly deployed two-thirds of its third, $600 million, early-stage fund, which it closed in 2015.

"What you saw, to be blunt and honest," says Palihapitiay, "was the migration of very traditional LPs that we admitted, and as much 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."

Certainly, he has some support by VCs who also see the winds changing. One of 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."

Indeed, Turck thinks Silicon Valley especially needs to start thinking differently, and fast.
"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,"  making 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. Indonesia? Eastern Europe? South America? To capture the one that comes out of a random place isn't so easy. I actually think the concept of creating a broad network globally, with this global contributory database of information is really very smart."