The art of venture capitalism (VC) is being transformed by the science of data analytics. Many startup investors are adopting data-driven decision-making to guide their lead sourcing and investments. The broad availability of data can help venture capitalists answer three crucial questions: Where are the best companies? Whether to invest? What KPIs should be set for the new company?
1.Where are the best companies
While the instinct for scouting great investments is usually developed through years in the field, VC associates can improve their scouting process by using data to analyze a variety of ecosystems. For instance, Hone Capital created a machine learning model by partnering with AngelList and is using the data available from sources such as Crunchbase and FullContact. Based on specific investment criteria, a VC such as Hone Captial can browse public and private data sources to identify and recommend the best seed deals. Following this model, Hone Capital has increased deal flow by up to 20 deals a week. Relying on similar processes, VCs have experienced a significant improvement in the diversity and quality of leads sourced.
2.Whether to invest in a particular company?
While there isn’t a lot of visibility into startup investments, predictive modelling techniques can help investors check their gut-instincts against the facts. Predictive modelling evaluates multiple factors that forecast the likelihood of a startup’s success. This works in the same way a credit score is calculated by assigning marks to a variety of attributes or factors. Some examples of insights that help determine if a company is likely to thrive are as follows:
Team background: Criteria for educational background, employment history, and entrepreneurial experience, especially if the management team has a relevant background in the field. Data shows that a startup with two founders from different universities is twice as likely to succeed as those with founders from the same university.
Funding: An important performance metric is whether a company will go on to raise an additional round of funding, from seed stage to series A. A seed investment of at least $1.5 million is an early indicator of a company’s future success. Those with less than $1.5 million tend not to raise the additional funding needed to be successful.
Digital footprint: Probably the most extensive source of information, especially for B2C companies, is a company’s digital footprint. Twitter, Facebook, web traffic, and so on, can provide useful insights for investors. By identifying keywords that express positive or negative sentiments, a VC can rank each company’s public sentiment quantitatively. The VC can set an alert to notify the VC of any “sentiment-changing” events.
Financial information: Analytics have enabled VCs to examine traditional financial sources and discover insights deep within central bank reports and the company earning statements.
3.What KPIs should be set for the new company?
Once a VC has made an investment, they put in benchmarks to track it’s performance. It’s fairly straightforward to determine the value of an established company by its profits and cash flow. However, VCs then establish specific metrics for their startup investments. This enables the VC to keep an eye on the meaningful numbers to make sure the business is heading in the right direction. This way the VC can quickly diagnose and resolve any potential problems before they become real issues. The most common key performance indicators (KPIs) include:
- MMR: Monthly Recurring Revenue
- CMMR: Committed monthly recurring revenue
- ARR: Annual Recurring Revenue
- ARRR: Annual Run Rate Revenue
- Growth in Recurring Revenue
- CLTV: Lifetime Value of Customer
- CAC: Customer Acquisition Costs
- Customer Acquisition Cost Payback Period
- Customer Churn: Gross and Net
- Conversion Rates: Sales Funnel; Site conversion; etc.
- Start with gross burn rate and net burn rate, then free cash flow over time.
All of these metrics essentially indicate the primary consideration: return on investment (ROI). The higher the number in the ROI equation, the more money a VC will make for every dollar invested. Finally, it’s important to establish key industry-specific metrics. At Phocas, we work with companies to establish industry-specific metrics as well as KPIs for their unique needs.
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