Data-driven VC #2: How to not miss an investment opportunity anymore
Where venture capital and data intersect. Every week.
👋 Hi, I’m Andre and welcome to my weekly newsletter, Data-driven VC. Every Thursday I cover hands-on insights into data-driven innovation in venture capital and connect the dots between the latest research, reviews of novel tools and datasets, deep dives into various VC tech stacks, interviews with experts and the implications for all stakeholders. Follow along to understand how data-driven approaches change the game, why it matters, and what it means for you.
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Let’s start with the most essential takeaways from my previous episode: VC is broken and the sourcing & screening stages are the most critical parts of the value chain as 2/3 of VC value is created here. Said differently, VC is a finding and picking the winners game. Having explored the shortcomings in the respective stages, major areas for improvement in the sourcing stage are more comprehensive coverage of potential investment opportunities (this is what I call the “identification”) as well as more complete, unbiased and accurate data on the respective companies and the people behind them (this is what I call the “enrichment”). We will come back to these terms later and zoom out to start with the question of all questions:
How to identify every company as early as possible?
The question for comprehensive coverage top of funnel is one of the most difficult ones to answer and top of mind for every investor, no matter the stage. Certainly, it becomes easier the later you invest as the number of potential investment opportunities across development stages (pre-Seed to pre-IPO) naturally decreases. The challenge itself, however, is structurally the same: See every company as early as possible. In order to get the answer, I’d like to take a bird’s view on the universe of different approaches and cluster them into human-centric and data-driven.
Human-centric sourcing approaches
Foot on the ground: Wasn’t even sure whether to mention this point as it’s that obvious, but for comprehensiveness and non-VCs among you I do. In the past, VCs were oftentimes used to founders flying in and meeting the VCs at their respective offices. Clearly, this trend flipped upside down. Nowadays, VCs fly around to meet the founders wherever they are. Even more efficient, many investors have opened satellite offices on the ground like in Paris at Station F and in Munich next to CDTM or got a desk in hotspot WeWorks like in Berlin or London.
Mentoring: In line with the “foot on the ground”, VCs started to offer free mentoring in promising incubator or accelerator programs like Y-Combinator, Entrepreneurs First or Techstars. This way, they get interactions even earlier than the prominent demo days.
Accelerators: Some multi-stage VC firms started to move upstream and as part of this trend even launched their own incubators or accelerators. Though different business, it’s still closely related, oftentimes managed by independent teams and certainly a great, proprietary sourcing opportunity for the respective firms. Examples include Sequoia Arc or a16z START, and given the recency of these kinds of programs, the questions of signaling and reputational risks remain open.
Student ambassadors: The list of uni drop-outs who founded category-defining companies is sheer endless: Facebook, Microsoft, Apple, Twitter, Square.. A range of investors have identified this trend and figured that it’s not enough to give a guest lecture and visit campus once a semester. To be top of mind of these youngsters, it’s oftentimes not enough to be on-site but actually, you need to be one of them. We all know that level of trust is different with peers and friends than with foreigners you might have met once or twice. To hear their crazy ideas, participate in these early brainstorming sessions and see the inception of a great company first-hand, a range of funds have extended their wider team and started to recruit active students into their campus programs. They oftentimes serve as part-time (junior) analysts or get a finders fee in case the fund ends up investing. Some examples include Picus Capital, Alix Ventures or Hook VC.
Angel networks: Following the same logic as the student ambassador programs, many VCs have started to recruit operators who bring close proximity to ecosystems and proprietary deal-flow into so-called “angel programs”. The main hypothesis is “great founders know great founders” and funds want to incentivize the well-connected ones among these operators to share info on promising opportunities with them. But only with them. Setups differ from more loose constructs of a simple finders fee (cash or shareholding in the respective investee) over angels who invest money on behalf of the fund but legally on their own, and where the fund then has an option to acquire the resulting angel portfolio (or sometimes only specific positions) at a fixed price until a specific point in time, to very close collaborations where angels invest legally and monetary on behalf of the fund. Sounds win-win but as always, the devil is in the details and it seems like no fund has cracked the winning setup yet. While the upside is clear, there is - similar to the accelerators - a significant downside in terms of signaling risk (for example “if angel A invested on behalf of fund Y and fund Y does not invest in the next round of the company, then there must be something wrong”; similar to funds not doing their pro-rata) and potential reputational damage for the fund. You can find a great summary of the different programs and requirements by Superscout here.
Research affiliations: Different from the US, European universities still lack proper setups to transfer their world-class research into practice. Tech transfer offices are as scarce as standardized terms for IP transfer and, as a result, significant potential is left on the table. To solve this problem, Earlybird has launched UNI-X, a pan-European first-check fund connected to a network of leading professors (multi-university affiliation #ResearchersPleaseReachOut) who are incentivized to share the most promising research and have access to a platform to complement teams. Examples of related but still different single-university affiliations include UVC which evolved out of the TU Munich ecosystem or Cambridge Innovation Capital which evolved around the University of Cambridge.
Fund-of-funds: More relevant for late-stage than for early-stage funds is the fund-of-fund strategy where the later-stage fund becomes a limited partner (LP) investor in a range of early-stage funds. Subsequently, they get access to proprietary information of the respective portfolio companies and can hereby establish a multiplier pipeline while at the same time ensuring early access/introductions to the prospects. Examples include US-based New Enterprise Associates (NEA) who is an LP in Europe-based Speedinvest, essentially as their extended foot on the ground on the continent, or Molten who is an LP in a range of European early-stage funds such as Seedcamp, IQ Capital or Earlybird. Similar but still different, many general partners (GPs) of multi-stage or growth-stage VC firms have invested privately as LP into different early-stage funds. Clearly, their motivation is not only financial returns but proprietary insights into the respective portfolios and trends, to eventually benefit with their own vehicle.