Where there’s money to be made, you’ll find investors…ok, hedge funds.

Jeff Hoffman keys on startup success (Photo credit: TechCocktail)

Leena Rao’s TechCrunch article yesterday on the return of hedge funds to startup investing identifies a trend that we all felt was happening but didn’t necessarily have the high-profile example to jog us. When Snapchat, the hot social app reportedly rebuffed a $3 billion dollar buyout offer from Facebook and instead, turned to go it alone by raising a $50 million round. it did so not by turning to venture capitalists.

Snapchat raised its money from a hedge fund (from Coatue Management, to be exact).

And there are other examples of hedge funds leaving the world of public market investing to place their bets on startups:

• SurveyMonkey. According to the WSJ. when online survey company, SurveyMonkey went out to raise an $800 million funding round, it tapped hedge funder, Chase Coleman, a Tiger Global cub, which lead the $400+ million equity investment.
• Hubspot. The online marketing software firm, Hubspot, raised $30 million from hedge fund Altimeter Capital and other institutional investors.
• Evernote. When my favorite note-taking/storage app, Evernote raised $85 million in late 2012. it did so by tapping AGC Equity Partners/m8 Capital and Valiant Capital Management at a reported valuation of $1.5 billion.

These are just a few of the most salient examples and to be fair, hedge funds frequently dabble in late-stage startups though they prefer the liquidity of public markets.

But there’s something else going on here and that has more to do with the changing nature of startup investments than the fact that hedge funds frequently make side pocket investments.

The changing startup financial ecosystem

The face of startup investing is changing. It’s becoming more transparent and open. The era of clubby deals — of some old guys sitting in a well-upholstered living room smoking cigars and drinking brandy out of snifter glasses — is quickly fading away.

Here’s what’s really happening:

• More transparency. With sites like AngelList or other equity crowdfunding sites like my firm, OurCrowd. for the most part, generalized dealflow is becoming commoditized. If you plug into the right social networks, an investor can get access to many of the same deals being poured over by institutional investors. It’s almost like an investor can become an armchair venture capitalist: take equity crowdfunding with some strategic connecting on Linkedin, and you’re good to go with at least some semblance of dealflow.
• Try it before you buy it. Few investors these days are investing in ideas. It’s way too easy to put up an idea for a product on Kickstarter. raise some money for it, and start building it. One of my colleagues just returned from the Consumer Electronics Show in Vegas and said he’s hearing of more venture capitalists creating term sheets dependent upon successful crowdfunding campaigns. By taking some risk out of the investment equation, this type of investing is attracting more types of investors.
• Inner circles expanding to be more inclusive: Given the regulatory moves afoot to open up private investing to more investors, like the 2012 JOBS Act, it’s just a matter of time before new players emerge to supply the capital to the most risky of investments. Hedge funds smell an opportunity and where there’s money to be made, you’ll find investors. It’s getting harder and harder to maintain a veil of secrecy over a good investment and ultimately, that makes for more liquid markets. This is happening in startups but it’s also happening in real estate and other alternative assets.
• Valuations moving up. Of course, not all deals are created equal. Investors will always have to fight to get the highest quality of companies to take their money. With deep-pocketed hedge funds competing for the same deals the rest of us are, valuations are being squeezed up. This obviously can turn out badly — it’s harder to make money at higher valuations. Buy low, sell high, right? Well, it’s beginning to look like buy high, sell higher.

Private companies in your IRA

If you look at other investable assets, the easier they are to invest in and the more liquid they are to trade, the more likely they are to become owned by a larger population. We’ve made investing in public companies really easy for the average investor to participate: we have a retirement scheme that gives individuals and companies special tax treatment to encourage them to invest. We have online brokers that have made buying stock and mutual funds as easy as clicking a button and as cheap as just a few dollars.

Today, investments as private companies are treated as alternative assets. It’s entirely conceivable in the future, when investors build long-term retirement portfolios, they’ll make private companies a core asset. This will be a tricky road — private investments are very risky and if you don’t know the rules of the road, you risk getting run off the road. Instead of turning to the NYSE or NASDAQ, people will turn to equity crowdfunding platforms (maybe the stock markets will own some of these platforms) or to private trading markets like SecondMarket or SharesPost to pick, transact, and manage their investments.

Investors in the stock market have a lot of information to educate themselves on what makes a smart investment, what constitutes a sound portfolio.

The same can’t be said for this new generation of startup investors. There just isn’t enough educational content for new investors in startups.