On a late Friday afternoon earlier this month, a dozen students crowded around a table in an office overlooking New York City’s Madison Square Park. Their mission: deciding whether to invest a chunk of a $3 million fund into a student-led startup.
The 20-something investors were carefully selected from East Coast universities such as Princeton, Columbia and New York University to serve as partners on the student-run fund, sponsored by the venture capitalists at First Round Capital.
With increasingly fierce competition for spotting early startup winners, some venture-capital firms are developing new strategies to find promising young businesses—even those whose founders are still in college and graduate school.
First Round’s Dorm Room Fund, a three-year-old student-run venture firm, is one example where student investors work as a team to vet the business ideas of their peers. Through local branches in Philadelphia, New York City, San Francisco and Boston, the fund so far has made about 80 investments total, typically for $20,000 apiece.
The students aren’t investing their own personal funds. All of the money comes from First Round’s own limited partners, which are mainly large endowments and nonprofits.
‘This is the first time they get to learn about accelerator programs, learn about term sheets, how to raise funding, how to build a team.’
—Peter Boyce II, of General Catalyst
The hope is that student investors—with some guidance and a couple million dollars—will be able to scout out a promising startup even if its founder may be still working on term papers.
“Joining the Dorm Room Fund was right in line with everything I was doing to help student founders,” said Rishi Narang, a computer science major at Princeton University.
The student partners in the Dorm Room Fund collect a 2% management fee that they use for travel, “pizza money” and marketing the fund on campuses. First Round profits if a startup goes public or gets acquired by a larger firm.
“We expect the Dorm Room Fund to generate long-term investment revenue,” said Phin Barnes, a partner at First Round Capital.
Overall, venture capitalists—bolstered by pension funds, university endowments, insurance companies and others looking to pump money into deals with the potential for huge payouts—are on track this year to invest the most money since 2000, according to data from Dow Jones VentureSource. Investments in U.S. venture-backed startups reached $15.72 billion in the first quarter of 2015, up 27% from the year-earlier quarter.
With all that capital floating around, worthwhile deals are becoming harder to spot, leading some venture-capital firms to experiment with the way they operate. “They’ve found themselves running out of places to invest because by the time startups get to you, they’ve been funded by angels and everyone else,” said John Coyle, a professor at the University of North Carolina School of Law.
“What you’re seeing here is [venture capitalists] going as early as they possibly can—the undergraduate level,” he added.
A few technology giants have been founded by students. For instance, Google Inc. was started as a research project by Stanford Ph.D students Larry Page and Sergey Brin. The beginnings of Facebook Inc. were in the dormitories of Harvard University, Mark Zuckerberg’s former school.
As the money “chases startups to the earliest stages,” the amount of risk for investors shoots up, Mr. Coyle said.
The fact that college students are choosing the startups to invest in doesn’t increase the odds of success. “These [deals] really are like lottery tickets, honestly,” he said. “There’s a lot of uncertainty and a lot of risk—even more so than traditional venture investments, which I wouldn’t bet the farm on.”
Until recently, most student-run investment funds were hosted by schools themselves, often with a focus on startups that were university spinoffs, or as a means of teaching business-school students.
University of Michigan’s business school founded Wolverine Venture Fund in 1997 with $2.5 million in donations from alumni, and it has since grown to $7 million through gains on investments. The fund, which calls itself “the country’s first student-run venture capital fund,” was an early investor in IntraLase, a university spinoff that commercialized the blade-free laser technology used in Lasik eye surgery.
The business school at the University of Wisconsin-Madison has a course tied to a $1.5 million fund, which can be invested in companies started by students in the class. The fund has made 20 investments since 1998—less than half of the startups have shut down, while a handful have been sold. “But it’s not as good as it may sound,” said Dan Olszewski, the program’s instructor. “Some companies that are two years old are still alive, but they’re not on the right track.”
By 2012, venture capitalists caught on to the idea, and began to give small groups of students the autonomy to fund their peers.
General Catalyst Partners, a Cambridge, Mass.-based venture-capital firm, started Rough Draft Ventures in 2012. So far, its student partners have invested in more than 35 teams, investing up to $25,000 in each. “This is the first time they get to learn about accelerator programs, learn about term sheets, how to raise funding, how to build a team,” said Peter Boyce II, an associate at General Catalyst who co-founded Rough Draft.
At the Dorm Room Fund, so far “a couple” of the fund’s investments have gone out of business “but most are still operating,” said First Round’s Mr. Barnes.
In 2013, its New York student group invested $20,000 in FiscalNote, a legal and analytic software business started by three friends who met in grade school.
Tim Hwang, FiscalNote’s co-founder, was a Princeton undergraduate majoring in public policy when he and his co-founders created what they thought was a solid prototype of software that could forecast policy outcomes.
Mr. Hwang reached out to well-known angel investor Mark Cuban. After a few discussions, Mr. Cuban agreed to lead FiscalNote’s first round of financing, meaning he would contribute a large amount of capital, oversee negotiations and introduce the company to other potential investors.
One of Mr. Hwang’s friends, a co-president of the Princeton Entrepreneurship Club and a partner in the Dorm Room Fund, later heard that Mr. Hwang was raising money and asked him to pitch his startup to the student-investor group.
Within a few days, the student investors emailed Mr. Hwang to let him know that the fund wanted to invest $20,000 in FiscalNote. In all, FiscalNote raised $1.3 million that year.
FiscalNote, which was just a few college students renting out a Motel 6 room in Silicon Valley less than two years ago, now has more than 60 employees and has raised over $18 million in investments.