Traditional investment culture is dominated by “gut feelings,” entrenched networks, and personal relationships — think antiquated visions of rolodexes and hand-shakes.
This is starting to change.
With the availability of new types of data — and new ways to process that data — a structural transformation for investing is underway. While human judgment and relationships will always be important, it’s becoming clear they are no longer the only variables needed to successfully manage money.
On March 6, Canaan hosted the first Fintech Central event of 2018. That evening, I explored the changing investing landscape — and attempted to forecast what’s to come — with Lisa Edgar, Managing Director at Top Tier Capital Partners, Arjun Sethi, Partner at Social Capital, and Ryan Caldbeck, Co-Founder & CEO at CircleUp.
Three big takeaways emerged:
1. A data-first approach to investing can reduce personal bias, open the door to entrepreneurs of all genders & backgrounds, and expand the ecosystem beyond the Silicon Valley & Alley bubbles.
Data is essential for the democratization of investing. More investors are turning to data to evaluate entrepreneurs and ideas in an objective way — removing the bias of a personal relationship with the founder.
Take Canaan portfolio company CircleUp. CircleUp acts as the liaison between early-stage entrepreneurs and capital markets – a function that has historically been unavailable to those small businesses. But, CircleUp doesn’t only offer the introduction, they come armed with a wealth of data points, insights, and benchmarks on that emerging business to drive a quantitative investment decision.
Social Capital recently introduced Capital-as-a-Service, where nearly 3,000 companies were considered on data alone during an initial six-month pilot (the service is now in private beta). No traditional pitch decks or opportunity for an investor’s personal bias to enter the equation. Interestingly, the demographics of Capital-as-a-Service’s chosen entrepreneurs were 42 percent female and a majority non-white. Compare that to this stat: female founders received only 2 percent of VC dollars in 2017. It’s still too early to say if these data-driven investments will elicit outsized returns, but it is certainly encouraging to think that this form of investing could lead to a more diverse entrepreneur class. “There’s something kind of beautiful” about being “behind the curtain” when being evaluated, said Lisa Edgar of Top Tier.
2. Data gives LPs, investors, and entrepreneurs more to work with and collaborate on.
Entrepreneurs may at first be wary about handing over their data to investors, for fear of being evaluated on data alone, without context. But, they should really see it as an opportunity to better collaborate with their investors to build and grow their businesses.
Investors today are using this data to inform initial investment decisions, but also post-investment recommendations to help provide operational guidance. For example, Canaan built a data-informed framework for marketplace investments, allowing us to make more rapid decisions around deals, and provide unique insights at the board level. After having collected data on multiple marketplace investments such as Instacart, Washio, LendingClub, Turo, and UrbanSitter, our investment team was able to make faster decisions on investments in Bellhops and Cargomatic with stronger conviction. We were able to build out a framework on unit economics and market expansion rooted in data, not gut feeling.
This is also the case at Social Capital, as Arjun explained — “We’ve seen what works and what doesn’t,” and, with that “shared understanding,” investors can work with entrepreneurs to analyze company data and offer recommendations on how best to build a successful business.
A similar approach is used by LPs at other end of the ecosystem as they look to invest in new funds — Lisa explained that Top Tier aggregates and blinds its data about private funds and shows VCs how they stack against their peers — a valuable data set that simply isn’t available elsewhere. “They get something out of it too” she said, compelling the investors to contribute their numbers regularly.
Data won’t come to investing overnight — funds must be willing to invest in their data strategy and infrastructure.
Data, inherently, “can make us better investors” said Lisa of Top Tier. We can be more informed and have more faith in the benchmarks we set for business success. But, we are in the very early days of data-driven investing and it’s still too early to say whether data utilization definitively improves returns. One big reason why? The amount of data available is still limited because it’s such a huge lift for funds to build out a robust data infrastructure. “We see a lot of private funds say they have a data strategy, but, when you scratch the surface, you see they have one outsourced engineer who only works part time — that’s hard to build a data strategy around,” said Ryan of CircleUp. “There is a massive barrier to entry.”
While moving to a data-based approach to investing may be slow (and costly), it’s clear that the number of investment models that employ such an approach will only increase in the days to come. The amount of excitement — and possibility for returns — is just too great for investors to stand on the sidelines.
A big thanks to Lisa, Arjun, and Ryan for joining us for such a special evening. Stay tuned for more Canaan Fintech Central events in 2018.