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VC software: platforms vs. discovery tools (the hunter vs. the hunted)

7 January, 2014

Recently I read a post by Li Jiang from Silicon Valley-based venture capital firm GSV Capital describing the venture capital ‘stack’ discussing software to support the value-chain for VC firms:
discovering >> identifying >> screening >> evaluating >> investing >> holding/managing and >> exit

One can clearly notice an increased sense of urgency with VCs to use more software to support their work, also here in Europe. The market has responded: many promising tools for VCs have been launched. And this, by the way, fits also with the trend towards “de-institutionalisation”: smaller VCs with leaner operations and more skin-in-the-game.

In particular we’ve seen the emergence of two types of software models:
(a) marketplace type platforms (many-to-many)
(b) big data discovery tools (one-to-many)

Marketplace type platforms are a logical way of matching supply and demand for startup investing. Marketplaces bring transparency, market discipline, and a level-playing field. Once critical mass is reached, marketplaces tend to grow stronger and stronger thanks to positive network effects. Taken to the extreme, they could eliminate proprietary deal-flow, although I have expressed some skepticism it would ever go this far.

One of the hurdles for marketplaces is the adverse selection problem: the best companies often won’t list themselves on any platform (this applies to angel rounds, series-A, follow-on rounds and exits). Granted, this emotional barrier has become becoming lower now that being listed on an M&A platform is an increasingly accepted practice (just like having your CV on LinkedIn doesn’t mean you are looking for a job). However, I expect that some of the best investment opportunities will continue to be done off-market (also see footnote 1 for an analogy with real estate portals). Moreover, platforms do not fully fit with the DNA of investors. VCs and angels like to take the initiative. They generally don’t like being pitched or being fed deals.

Enter, data discovery tools. Using data-crawling technology to filter out the noise and find growth is a great value proposition. Such tools sit much better with what VCs want, allowing them to be be in the driver’s seat, be the hunter. It allows them to discover new “hidden gems” (= proprietary deal-flow) in the best case, or worst case be able to filter out the noise (= low growth businesses). Private company information is not easy to find however, almost by definition, especially for B2B companies. In addition, negative network externalities can also occur, where more users make the product less valuable (“congestion”). Indeed, many VCs are looking to add in-house built technology on top of outsourced technology to maintain a competitive edge, similar to the way many hedge funds work (see footnote 2).

Marketplaces and discovery tools are of course completely complementary and likely to be used in combination.

So where does dealroom.co fit into this?

Dealroom is neither a marketplace nor a data provider. We provide information but based on a crowd-sourced model. We add a layer of curated information through in-depth research. VCs are primarily looking for growth/traction. And those who have growth to demonstrate, have an incentive to display it. For these high-potential companies, Dealroom acts as a fiduciary making sure the information gets seen by the right parties only. In order to filter out noise, our research team pre-qualifies companies based on basic size and growth metrics, using a mix of publicly available data sources and the proprietary information we receive directly from the companies.

Footnotes:

  1. There is an analogy with online real estate portals. They also bring transparency and market discipline, but many of the best properties are very often only available off-market for an initial period and gone before they are ever seen online. Indeed, when recently looking for a property, I noticed that a majority the best properties listed online had already been rented out. It is bait-and-switch practiced by nearly all real estate agents, on the main platforms.
  2. Hedge funds have a lot more data to work with and are in a technology arms race which led to big hedge funds winning from small ones due to superior technology budgets, hurting small investors who do not have access to these technologies.