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Venture capitalists eating their own dog food: How private equity investors are using technology and analytics

(NOTE: I’m now working on an updated version of this paper; please contact me with suggested edits.)

Private equity and venture capital investors are copying our sisters in the hedge fund and mutual fund world: we’re trying to automate more of our job. But we’re doing it slowly.

VCs tout our industry as frontier technology investors, but most of us are using the same infrastructure tools we have used for the past 20+ years: Excel and recent college grads searching Google. We’ve seen some modest progress in people upgrading from Excel to Google Sheets; use of some CRM; and a cloud-based storage service. But beyond that, not much. According to Sebastian Soler of Lux Capital, under 5% of US VCs have a full-time team member focused on technology. (Sebastian is a cofounder with me of PEVCTech.com, an online community for investors in private companies who want to use technology to be better investors.)

Johann Kratzer of Blue Future Partners, a fund of funds, observed, “The majority of the hundreds of funds we’ve diligenced rely predominantly on their relationships to source deals. However, an increasing share of VCs in our database, are trying to build a competitive advantage by crawling large amounts of publicly available data and building analytical functions to flag companies with accelerating traction to them. However, it’s still quite unclear, how (and if) the use of technology correlates with financial returns for VC firms.”

Historically, investing was a manual, artisan process. An investor had few hard metrics other than the actual financials, and little technology to make the process scaleable. Over the past few decades, better metrics became available, and investors could take a more analytical, data-driven approach. The extreme example of this are algorithmic investors in the public markets, who design algorithms which trade on the designer’s behalf, as opposed to making trading decisions directly. High-frequency trading, algorithmic by its nature, is estimated to account for at least 50% of US equity markets trading volume.

Quantitative, technology-enabled investing in private companies makes sense, but is structurally very difficult, and will become a more common strategy at a much slower rate. The private markets are more opaque; they offer less of the hard data critical to a true quant approach. In venture capital in particular, early-stage companies are often operating in frontier industries, where the rules are unpredictable and conventional analytic frameworks may be misleading. Even for later-stage companies with predictable financials, the lack of liquidity, audited financials, and standardized metrics creates real challenges to scaling quantitative investing. However, there is a lot of room to use technology to make the actual investing process more efficient.

Why is it now more feasible to use technology in the VC investing process? Sebastian Soler observes, “Structured, accurate and accessible data never really existed before for the private markets, at scale. Advances in machine learning, specifically natural language processing, have made generating these baseline, aggregate datasets possible, at scale, with high accuracy. Sources like Crunchbase, AngelList, and Seed Invest even give this data away for free or very low cost. The problem that faces startup investors now is how to mine this new data layer efficiently to increase returns.”

I’ve primarily seen analytic techniques used in origination, filtering, and in portfolio company recruiting, but technology can be used throughout the eleven steps of the private company investing process:

The 11 Steps of the Private Company Investing Process

1) Manage the firm 

Of course, before you can invest, you have to manage the firm. This is harder than it sounds, given that so many investors have training as deal-makers not as managers. Our industry is not known for producing great managers. 

Point Nine Capital uses 15Five for team feedback.  HOF Capital uses Asana for team management.  I use several living Google docs to maintain minutes and group agendas for fixed weekly meetings, and another live Google doc to maintain my database of companies I’m marketing to other VCs.  That document provides cut and pasteable text I can share with other investors, based on their stage, focus, and appetite.

2) Market 

Many tools designed for B2B marketing in general are also relevant to investors. I know of funds using Constant Contact, Goodbits, Pardot and Publicate to create light newsletters for internal and external consumption. A major angel group uses Influitive, an advocate management tool, to track, activate and motivate their members. Other VCs use Contently* or Social Native* to create relevant content. Meyler Capital is taking the analytical rigor of modern internet marketing and applying it to fund marketing.

Point Nine Capital’s website is now powered by Contentful; they use Unbounce for landing pages; and Typeform for surveys and other data collection. “We’re using … TinyLetter for our “Content Newsletter” … and Buffer to schedule social media posts. Last but not least, we still use MailChimp to publish our (in)famous newsletter.”  I also use Mailchimp for the teten.com and pevctech.com mailing lists.  Point Nine Capital uses Mention for media monitoring. Teten.com is built on WordPress as my content management system.

3) Raise capital

The historic capital-raising process is driven by face-to-face networking and salesmanship. A more efficient approach is to mine the data exhaust from the limited partner universe to identify those LPs most likely to find your fund attractive, and focus all your energy on them. I previously posted a detailed presentation with sales technology tools useful for B2B sales.

I always make a point of keeping firm records updated in the major data-trackers tracking the VC industry: CB Insights, Crunchbase, Dow Jones, Preqin, Pitchbook, and ThomsonReuters.  LPs, coinvestors, and press use these tools, so I work for free for these data vendors to make sure that their data about our activities is correct. (This is a great example of why data businesses have substantial moats.)

Relationship Science makes it easier to understand and map social networks into potential limited partners. Cobalt for General Partners helps GPs to optimize their fundraising strategy. MandateWire and FinSearches provide leads on limited partners with new mandates which might fit your fund. Evestment is a platform for capital-raisers; Evestment TopQ automates private markets performance calculation.

I am a heavy user of DocSend, a secure content sharing and tracking platform that can be used to seamlessly share recurring materials with potential LPs. It provides analytics to track shared materials across target senders, and improve the content for future leads.  Point Nine Capital uses Qwilr to create modern, mobile-native collateral.

Most funds open data rooms to share previous reports, performance data, pitch decks, legal docs and other fundraising material with LPs.  I’ve seen funds using Ansarada, AltaReturn, Box, CapLinked, dfsco, Dropbox, Digify, Drooms, Google Drive, iDeals, Intralinks, Ipreo, Merrill Corporation, and SecureDocs for their Virtual Data Rooms. These same tools are used by companies raising capital.

I’ve also experimented with using services which are marketplaces between LPs and GPs: CEPRES, DiligenceVault, FundVeil, Harvest Exchange, Palico. Some funds are using technology-enabled intermediaries to help them sell to retail LPs, e.g., Artivest, iCapital Network.

4) Originate investments

Chris Dixon, Partner, A16Z, observes, “Success in VC is probably 10% about picking, and 90% about sourcing the right deals and having entrepreneurs choose your firm as a partner”.

For both origination and competitive due diligence, a host of data companies aspire to be the “Bloomberg of private companies”, including Boss Insights, CB Insights, Crunchbase, Cyndx, DataProvider, Oracle DataFox, FuelUp, Qodeo, Tracxn, and Zirra. Data companies focused on early-stage startups include Aingel, fundsUP, Preseries, PredictLeads, and Sploda. Data companies more focused on later-stage companies include Avention, Bureau Van Dijk, BizQualify, Dow Jones, FactSet, Genesis, S&P Global Market Intelligence, DueDil, Core 2 Group, D&B Hoovers, InsideView,LexisNexis, Pitchbook, Preqin, PrivCo, SourceScrub, Thomson Reuters, and Unquote. Coalesce address the more general problem of searching through large data sets for best fits. A number of analysts have particular focus on serving the customers of technology companies, e.g., Gartner and 451 Research.

Investors are also mining such sources as product crowdfunding sites (Indiegogo*); tech communities (Producthunt); angel group platforms (Gust,Proseeder); expert networks (e.g., Atheneum Partners, AlphaSights, Dialectica, CAPVision, Coleman Research Group, GLG, Guidepoint, Insight Alpha, Lynk Global, Maven Research, Kingfish Group (specialize in private equity), Primary Insight, ProSapient, and Third Bridge); highly gated professional networks (Voray); buyer review sites (Capterra, GetApp, G2Crowd, SoftwareAdvice, IT Central Station, TrustRadius); technographics vendors (Datanyze, HG Data), family office coinvestor networks (Sharenett); and angel investor networks (AngelList, CircleUp, FundersClub, OurCrowd, Republic*, SeedInvest) for leads. Russell Rothstein, Founder and CEO, IT Central Station, said, “We see VCs on our site very often. They read reviews of the products of target investments. And also they frequently visit our comparison pages where they compare one company with another.“

Later stage investors are using private company marketplace services focused on more established companies, listed below under “Exit Investments”.

Pioneer runs an extremely open contest focused on lowering the bar to raising capital for “scientists, artists, entrepreneurs and civic activists.”  Members of GSV Passport™, an online entrepreneur community, have access to “100+ mentors, 450+ investors from all over the globe, hundreds of templates and guides, and $450K in free and discounted services from our 50+ preferred partners.”  On Deck focuses on connecting talent in transition with opportunities.

I use Feedly to track information about the companies and industries I am tracking, and share that information internally.  I use Superhuman, an email app which speeds up my email processing, and also gives me background information on all of my correspondents.  Another VC said, “I’m a heavy user of Streak, which is a CRM that lives in your Gmail and allows you to create contact pipelines, snooze / track e-mails, save snippets, etc. For networking, I’ve started using Clearbit and Hunter to verify e-mails, and have Dux-Soup plugged into my LinkedIn to streamline some of the sourcing processes.” Another provider which identifies email addresses of strangers is ContactoutLeadIQ Scout provides access to peoples’ email addresses as you browse websites. 4Degrees helps leverage your network for sourcing.

DealSheet and Sutton Place Strategies help private equity funds identify the best-positioned intermediaries (investment banks) for their sector.

For more on gathering data and using it to assess companies, see How to Assess Startups Using Machine Learning.

Hilary Mason, Data Scientist in Residence at Accel Partners, has a TED talk on how she replaces herself with a shell script to handle her email deluge. She is a model for us all!

5) CRM

Custom CRM solutions for PE/VC funds are offered by Altvia, Backstop Solutions, DealCloud, Drooms Dealflow, EquityTouch, SalesLogistix, Satuit, Sevanta Dealflow, Navatar, Salesforce, SalesforceIQ, Obsidian Suite,  and Touchstone. Numerous VC funds rely on more general CRM and sales funnel solutions like Pipedrive, Streak, and ZenDesk, and task management systems like Basecamp and Trello. Some VCs are using Act-On, Ebsta, or Hubspot to support their CRMs. Skype and Zoom are useful for video/audio conferences.

Point Nine Capital uses Contactually for contact management. I use FullContact to import business cards and sync other data sets with my CRM. 

6) Due diligence

AskWonder* provides short-form custom research on almost any research topic, e.g., “Tell me the major competitors to ____”.  Earnest Research* mines proprietary data sets (e.g., credit card data) to provide analyses unobtainable through other means, e.g., “How much did consumer spend on each of these 5 competitors grow last month?”  To measure product usage and traction over time, I have used tools like Alexa, AppAnnie, and Google Analytics. To quantify consumer trends and market opportunities, useful tools for “top down” assessments include IBIS World and eMarketer. For more rigorous, bottoms-up sizing exercises I suggest tools such as Statista and the United States Census Bureau (also their North American Industry Classification System database) to help identify more specific data.

The majority of funds are using the popular B2C websites and services for basic due diligence, e.g., Linkedin, Twitter, HackerNews. TruthFinder and Intelius provide basic background vetting. Pacer is useful to search prior litigation, bankruptcies, etc. Opencorporates helps in hunting prior company histories and principals. Pro Publica has a Nonprofit Explorer database searchable by principal name on all nonprofit filings, so you can see a person’s nonprofit activities. Some VCs are using automated tools to assess companies’ stacks, e.g., Builtwith provides insights into how a website was built. Corsis uses benchmarking data to understand technology spend patterns.

Lean Case provides standard business models & metrics, so you can apply a standard approach to business planning, modeling, and profitability tracking.

Spring Lane Capital uses a highly-structured, deep-dive interview format with founders, which they compare internally with an in-house scorecard.  Tribe Capital has developed A Quantitative Approach to Product Market Fit.

7) Negotiate 

I gain insight into the management style of portfolio company management by assessing their social media activities and digital exhaust. If you’re negotiating with a CEO showing photos on his Instagram of yachts and parties, you might want to particularly put in controls on his expense account.  The Pocket Negotiator is very early-stage attempt to aid in the negotiating process itself.

Bulletpoint Network is trying to improve financial modeling by enabling more sophisticated scenario planning. Modano standardizes Excel models to improve comparability and reduce error rates.  GF Data collects and publishes proprietary valuation, volume, leverage and key deal term data contributed by over 200 lower-middle market private equity funds and other deal sponsors, providing a unique negotiating tool.

For negotiating a contract, I’ve looked at Anduin Transactions, IroncladApp,SpringCM, Concord, ContractRoom, Dolphin Contract Manager, and Juro, and SRS Acquiom. Contract Logix helps to generate contracts with preapproved terms. Agiloft, ContractSafe, ContractZen, Contractworks, and Entity Keeper help in managing your set of executed contracts. DocuSign is steadily reducing the need for paper signatures, and is a more streamlined method for communicating contract changes in a secure manner.

Atlassian open-sourced their M&A term sheet, a very aggressive move which helps smooth the M&A process, by reducing the number of degrees of freedom in a negotiation.  This move also undoubtedly created more inbound M&A opportunities for them.  

For the broader use case of helping startups execute their legal paperwork, Clerky (in US) and SeedLegals (in UK) are focused solutions.

8) Monitor 

Melissa Craig, Director of Financial Ops, Lukka, Inc, observes, “LPs want to know and have a right to know, in near real time, how each company in the fund is performing. But, GPs are overwhelmed by investor requests because they don’t have the technology that makes transparency possible. All the outputs that investors want are in the monthly financial data that funds collect, normalize, analyze and report. Yet, according to my own surveys, a majority of private capital funds (including funds that specialize in fintech!) still perform the repetitive functions of data collection and investor reporting manually.”

The simplest way to track a company’s performance: have them give you access to their internal metrics dashboard. But some companies are not comfortable with that level of transparency, and of course the data is inconsistent across multiple portfolio companies’ dashboards.

Jaime Hildreth, Managing Director of GP and LP Strategies at Ipreo, said that 97% of Ipreo’s GP clients report that data requests from LP’s have increased over the past two years. Close to 80% responded that manual processes, such as tracking down support, preparing reports and pulling data from different sources, are the biggest pain points they face in the valuation process. Satisfying LP demands and streamlining the valuation process are primary drivers in those clients’ adoption of Ipreo’s portfolio monitoring and valuation solutions, iLEVEL, iVAL, and Qval.

Monitoring and reporting solutions include BaseVenture, Burgiss, Davigold, DocDep, eFront FrontInvest, Framework, Investors Economic Assurance’s CapAssure, Netage Dynamo PE, Q-Biz Solutions, Qualtrics, SS&C GlobeOp, and Vantage Software. Fund/SPV management services specifically are provided by Assure Services and Proteus Capital.

ff Venture Capital hired two full-time engineers to build out Totem. Totem is an operating system that makes investors smarter by helping them leverage their knowledge, relationships & insights. ffVC Partners kept going into meetings and showing other VCs the app on their phone, and hearing, “I could really use that—that’s like having an Analyst in your pocket.” As of the beginning of 2017, ffVC spun out Totem into a separate business. Another neighboring vendors include Kushim and VisibleVC. Carta and ShareWorks by Morgan Stanley track private company cap tables. 

From a startup’s point of view, Abaca helps a company identify in a standardized way their level of development.  The self-assessment methodology, pioneered by Village Capital, is called VIRAL for “Venture Investment Readiness and Awareness Levels.” 

9) Accelerate portfolio company value

Many portfolio acceleration VCs work to evangelize modern analytical tools to our portfolio companies, particularly to improve their board management, research into new business ideas, sales, recruiting, and financial management.

The segment with the best developed tools are providers of board management systems, e.g., Aprio, BoardEffect, Boardable, BoardBookit, BoardDirector, BoardPaq, Boardvantage, eBoardSolutions, Diligent, Dilitrust, DirectorPoint, Loomion, Passageways. That said, the quick and dirty approach to using technology for better board stewardship is just to use existing file sharing systems (Google Drive, Dropbox, Box, etc.) and project management and collaboration tools (Asana, Huddle, Basecamp, Sharepoint, Central Desktop, Trello, etc.)

For most investors, the most important tool for supporting their companies is their network. We can use technology to make that process far more efficient.  I wrote a book about this, The Virtual Handshake: Opening Doors and Closing Deals Online. For example, you can use Boardex and Relationship Science give you background on targeted influencers and how to get introduced to them. Crystal tells you how to influence a particular person. Qnary builds out your team members’ virtual presence. Clara and X.ai are virtual assistants who can coordinate meetings.

 

Accordion has launched Maestro, a technology platform designed to institutionalize a private equity firm’s unique approach to portfolio operations. Foundry Group is using their portfolio company Monday to aggregate portfolio companies’ job postings on their own jobs page; Point Nine Capital uses Recruitee for the same purpose. Other firms are using Talent Relationship Management tools, e.g., Thrive

Sapphire Ventures launched SV Explorer and AXA Venture Partners offers the AVP Library. Both are online discovery tools for corporate and IT leaders to learn about emerging technology companies. These VC firms are positioning themselves as trusted advisors to large enterprises on the right startups whom they should buy from or invest in.  

One of the most important aspects of accelerating portfolio company value is helping your companies raise their next round.  I use the vendors of PE/VC investing data I list above to track the interests of potential private equity/VC coinvestors, and selectively introduce investee companies as we build out a syndicate. A number of companies help companies (as well as funds) who are crowdfunding manage the process in a legally compliant way: FundAmerica, iDisclose, RegisteredTransferAgent,VStock Transfer, and Wealthforge. Pitchbot.vc is an AI bot which helps companies refine their sales pitch to VCs. Signal is a fundraising tool for founders run by NFX Guild, which identifies the most relevant VCs for you.

From a startup’s point of view, vendors like HG Data, Stackshare, and Stacklist help CEOs identify the right tech platform on which to build their business. FounderSuite* helps early-stage companies in their fundraising process. The Long Term Stock Exchange is building out a set of tools for founders for managing their cap tables, 409A valuations, cash on hand, options pool, investor relations, etc.

10) Report

Many PE and VC firms use Archway Technology, AltaReturn, eFront, KPISoft, or Sungard Investran for their fund accounting. ComputerShare provides financial administration for private and public companies.

Advise Technologies focuses on regulatory reporting. Imagineer Technology Group provides solutions for investor relations, fund marketing, and reporting.

Hedge funds don’t want you sharing their letters, but unfortunately you’ve got an iphone and can take photos of their confidential information. Some technology vendors are providing options to limit distribution of confidential information from GP reports. DRM services to help with this goal include Blackberry Workspaces and Citrix ShareFile.

11) Exit 

A range of companies are working to make the M&A process more transparent and less haphazard for later-stage companies, including Axial, BankerBay, Intralinks Deal Nexus, Interexo, and MergerMarket. EquityZen, SharesPost, and ZenPrivEx, help employees and investors liquidate their positions in late-stage companies. Fortis manages the post-closing process on behalf of selling shareholders in private M&A transactions. MeltingPointSolutions is an online market for secondaries in alternative assets. ExitRound helps early stage companies identify buyers in smaller exits. 

Some private equity funds are quantifying their exit strategy in a concerted way. They are tracking information available on Pitchbook, Bloomberg M&A, and other similar sources to conduct factor analysis in order to identify a series of factors that would kick-off the exit process. According to Mariya Osadchaya-Isa, Head of Growth at Mercury, one fund she has a relationship with, “tracks the available private company data for same sector companies and the relevant exit data and use basic correlation analysis to identify moments of the largest possible multiple expansion. This process is very similar to what a growing number of PE houses are doing during origination, so I feel it’s a natural extension of their capabilities to do this in order to more effectively time the exit. This also can be a valuable tool for increasing fund transparency and communicating with LPs.”

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Stereotypically, venture capitalists are viewed as less numerically focused than private equity investors. With regard to analyzing a given company’s financial model, that is a reasonable stereotype, given that VCs do not typically use financial leverage and financial forecasts of early-stage companies have a very high uncertainty rate. That said, I’d suggest the VC industry is more advanced than private equity in using technology in many other steps in the overall investing process, given the technology savvy of VCs, the transparency of many companies in the technology industry, and the relative receptivity of our limited partners to trying new ideas.

In private equity, the investors most proactively trying to use quantitative techniques are primarily sector specialists. According to one study, sector specialists regularly outperform generalist funds, returning an aggregate 2.2x Multiple on Invested Capital versus 1.9x MOIC. Sector specialists have always subconsciously correlated certain factors as drivers for future growth, but this knowledge is now being distilled into quantitative analysis.

Ms. Osadchaya-Isa, who worked previously at a sector-focused private equity fund, observes, “Sector funds, because of their ability to mine sufficiently targeted data, are working backwards to identify key correlations between different KPIs — including more unusual ones like positive PR releases to more basic fundamental analysis — that drive value at exit. This information is used to automate screening during origination. Automated screening ensures a higher quality deal pipeline that isn’t as prone to performance drags like mission creep and personal bias. Sector funds lend themselves well to doing this because it’s easier to quantify the characteristics which drive value on a sector basis, e.g., if you focus on SaaS companies you can identify annual change of >10% in recurring revenues as an indicator of future stability of revenues. This kind of ability to build a multivariate analysis suitable to be deployed on a company by company basis is not suited for generalist funds, unless they have sector strategies nestled underneath a generalist umbrella.”

One global institutional investor is investigating setting up a large-scale co-investment vehicle, similar to Correlation Ventures, but focused on private equity transactions. They are looking at doing this as an exclusive partnership with one of the leaders in the private company analytics and investing space. Their intent is to enable any private company investor leading a transaction to click a button, see a short list of criteria, and then quickly obtain additional co-investment capital to close the transaction.

My long-term vision is to build an end-to-end technology platform which automates every possible step that can reasonably be automated. We have a long way to go!

UPDATE: For Part 2 of this paper, see What’s Your VC Tech Stack? Results from a Survey of Early-Stage VC Funds.

I have embedded below the deck from a talk I gave at the “Alpha Innovation Required” summit:


For further reading:

The Ultimate Early-Stage Investor’s Tech Stack
NBER Overview of VC Data: Opportunities and Challenges
Stanford List of Venture Capital and Private Equity Sources
Harvard Business School Current Research Sources for Private Equity
Private Equity Software and Services Directory
The VC Software Stack — the Untouched Vertical
A (Micro) VC’s Tech Stack, and the sequel, Revisiting Point Nine’s tech stack
83 VCs using data/ai/proprietary software to better source, evaluate and support investments

You can see the survey we ran on the tech stacks of VC firms here.

* I’m an investor in the company.

Special thanks for their comments to Blue Future Partners, Karim Fattal, Steven Greenberg; Clay Hunt, Andrew Kangpan; David Levine; Mariya Osadchaya-Isa; Sebastian Soler; Andrew Sudol; Jim Tousignant, CEO, FinTech Studios; Franklin Tsung; various anonymous friends; and to Farah I. of ffVC portfolio company AskWonder.

Guest-contributed at AlleyWatch.

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