After reading a lot about the ‘AI based investment approach’ of some Venture Capital investors I take the liberty to share my thoughts on this matter.
AI in one sentence:
Software technologies that make a computer or robot perform equal to or better than normal human computational ability in accuracy, capacity, and speed.
First of all — I do respect the ideas and thoughts from other VCs about an ‘AI based investment approach’ but IMHO: a healthy startup ecosystem doesn’t work like this.
The basis of an investment decision in an early-stage startup is the founding team. It is not possible to automatically collect or scrape enough relevant data about a founding team of a young startup if you want to invest as early as possible (first institutional money).
Let’s focus on two main question:
Who is the center of gravity of every startup ecosystem?
How does the deal-flow process of successful and established VCs really work?
The founders and entrepreneurs are the center of gravity of this ecosystem. Without driven and skilled founders we wouldn’t need investors or all the other stakeholders (e.g. M&A advisors, lawyers, etc.). For an investor it is key to be known by these founders and for an early stage investor it is important to get in contact as early as possible — even before the startup is founded. That’s why I can’t see an ‘AI based investment approach’ as the basis for a VC’s deal-flow.
Most VC firms have a clear investment strategy and focus. A VC is executing on its defined investment process. At the beginning of this investment process is the ‘deal-flow’. The term ‘deal-flow’ sounds a bit rough but it is not meant to be disrespectful at all. It is just a term. At Capnamic Ventures we have a relevant deal-flow (within our investment strategy and territory) of about 1,800 deals (pitch decks) per year. About 50% of all deals are from founders directly approaching us. About 30% are referrals and introductions. Across the entire Venture Capital industry there is a rule of thumb that the vast majority (about 75%) of the initial investments in young startups by VCs are based on referrals and introductions. There are some Silicon Valley based VCs who are focussing on referrals only in their deal-flow.
I strongly believe in the word of mouth effect. If a VC is doing the good job, the right deals will follow. It is not a short term game to build up this reputation — a VC has to do it on a long run.
A Venture Capital firm has to build an image and reputation to be known for its focus, strategy, values, support, skill and the way to work together. Venture backed founders will share their experiences on the VC with young (new) entrepreneurs, other stakeholders and the media. Founders, entrepreneurs and teams will find the right investor. Good teams will be able to pick and choose their investors. Startups are not just an asset which can be found and evaluated by algorithms.
For a late-stage investor (B rounds or even later) a data-driven sourcing and investment approach might make sense. More established companies can be tracked based on industry specific KPI’s.