👋 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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The future of VC is augmented. Why? Well, I’ve described throughout the past ten episodes (see here for example) that the historic purely human-based VC model has been inefficient, ineffective, subjective and non-inclusive, eventually leading to on average sub-optimal returns and unfair distribution of capital. Remember that talent is distributed equally but capital is not, and VCs as gatekeepers are responsible for it.

As a result, data-driven approaches have started to change the industry to become more efficient, effective, objective and inclusive so that capital gets allocated to those who deserve it most and have the highest likelihood of success. However, independent of the benefits of data-driven approaches, I do not believe in a fully automated VC either. Not today and not in the future.

Why VC won’t be fully automated today or in the future

“VC is more art than science”, this is what many VCs told me when I initially started exploring data-driven approaches and automation more than 5 years ago. Today, I see what they meant and like to highlight four major areas across the value chain where data-driven approaches are insufficient and where it’s crucial to have a human in the loop/lead:

• Inbound deal flow: I discussed in detail why deal flow generation should be automated, leading to comprehensive coverage and a holistic picture of every company top of the funnel, see my previous episode here. While this certainly helps to see every company as early as possible, we rely on a proper screening algorithm to cut through the noise and trigger a reach out to the most promising companies at the right point in time. On our little evidence today, this seems to work quite nicely, specifically in B2C/D2C-focused and open-source businesses.

  VCs need to be top of mind for entrepreneurs

  Sometimes, however, it is difficult or impossible to identify inflection points outside-in, specifically for B2B startups. For example, assume a B2B company converts a pilot customer into a lighthouse recurring contract customer which in turn creates a potential domino effect for subsequent customers that see the new logo and are thus more likely to convert. If neither party publishes the news somewhere online, data-driven approaches would struggle to pick up the initial conversion signal and likely miss out on the right point in time for outreach. Therefore, data-driven VCs would either need to wait for the success signal to be picked up (which might take too long) or rely on founders to reach out.

  “A VC fund needs a strong inbound strategy and this explains the rise of bat signals from venture funds — blogs, podcasts, newsletters by funds and VC investors” by Sajith Pai in his “Narrative Capital” post here

  This is what VCs call “inbound deal flow”, meaning founders reaching out to the VC which is the opposite of “outbound deal flow”, meaning VCs reaching out to the founders. Data-driven approaches are outbound only, but in reality, VCs need to complement these efforts with inbound deal flow to overcome the above-described information asymmetry. VCs need to be top of mind for entrepreneurs within their coverage.

• Assessment: Creating a single source of truth across publicly available data but also privately collected information (like pitch decks or notes from founder meetings) increases efficiency a lot. Moreover, success scores and automated competitive landscapes, among other features, help investors to put things into context and draw their conclusions more effectively. As a result, VCs can assess more companies in greater depth and consider more data that eventually put them in a better position to make the right investment decision.

  Investors need to spend time with the founders to see the “fire in their eyes”

  Equally important for the assessment, however, is the interaction with the founders. Although there exist some explorative studies that examine how founders’ facial expressions, gestures or tonality can be recorded and used to predict the likelihood of success, I strongly believe that investors need to spend time with the founders to see the “fire in their eyes”. Assuming all “hygiene factors” and general business metrics are on track and boxes are ticked, the ultimate call to invest or reject depends a lot on the human interactions with the team. This part of the assessment process can and will not be automated anytime soon.

• Access: Actually one of the most critical aspects is access to an opportunity at two different points in time. Firstly, investors need warm introductions to founders as soon as they have identified a promising opportunity through their sourcing and screening efforts. Founders need to be open for a conversation otherwise all sourcing and screening are pointless. The worst case for the initial connection is to depend on cold reach out, specifically for “hot deals” conversion rates are rather low. A broad and deep network is very important to ensure access to an introductory meeting.

  Tables turn and founders need to decide if they actually want to work with the investor. Doing an investment is a two-way street.

  Secondly, once investors decided to invest, the tables turn and founders need to decide if they actually want to work with the investor. Strong references, value creation capabilities and personal fit are important here. Doing an investment is a two-way street.

• Portfolio and board work: Once a deal is signed and closed, it’s all about delivering on promises on both sides. For investors that means opening up their network, making introductions, helping with recruiting, sharing product feedback, sparring strategy and a lot more. In a nutshell, all human work. Yes, a lot can be automated and made more efficient but most parts still require humans in the loop, i.e. an augmented approach. I will share more on this in future portfolio value-creation posts.

The future of VC is augmented and requires a superior firm brand, personal brand, social skills and people judgement

Differentiating the four dimensions above based on “what is in control of the VC versus what isn’t” allows us to split them into two groups: 1) “inbound sourcing” and “access”, and 2) “human assessment” and “portfolio work”. For the first group, there clearly exist intangible external dependencies as a) VCs need to be top of mind for founders to reach out to them and b) VCs need to have the right set of arguments (besides good terms ;)) to make founders decide for them. Doing good or bad on 1) eventually comes down to a superior firm brand and personal brand.

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For inbound sourcing, founders reach out to either selected successful funds who have previously invested in the startup’s industry, technology and/or geography, or to individual investors whom they perceive as thought leaders in the startup’s domain. Same holds true for access. Founders want to bring in successful funds and partners who can add tangible value in the startup’s domain. Additionally, they serve as a signal to the external world that the startup was able to convince actual experts in their craft (very often the case that some angels are brought in because of this signal too). This perception is not in direct control of a VC but only indirectly, see the quote on personal/firm brand from Wikipedia below.

Personal/firm branding is the conscious and intentional effort to create and influence public perception of an individual/firm by positioning them as an authority in their industry, elevating their credibility, and differentiating themselves from the competition

Doing good or bad on 2), on the other hand, is mainly about social skills and good people judgment. For human assessment, it’s obviously important that an investor actually knows what the “fire in their eyes” looks like. You need to know what good looks like before you can spot it. Similarly, portfolio work is all about actual value add through network, the VCs extended team/platform and the partner’s individual expertise. This is all in direct control of a VC.

While social skills and people judgment are hard to learn and rather a given (or not), firm and personal branding are a toolset that every VC (and founder) should know by heart. If you’re interested in the topic, just vote above and I will write a deep dive piece on personal and firm branding 101. Otherwise, the next episode will be again nerdier and more data-centric. Your call :)

Stay driven,
Andre

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