Why VCs Can’t Be Experts All the Time
To fully understand the vast array of tech start-ups seeking funding today, venture capitalists need a range of knowledge that is nearly impossible to comprehend.
A recent report by Spanish bank BBVA identified 14 distinct technologies neologisms emerging in recent years, each offering opportunities for investors but also requiring in-depth understanding of a specific industry, market or technology. And these 14 categories, including fintech, cleantech, and biotech, are just the ones that have entered the mainstream. There are many other subcategories.
The truth, of course, is that it’s impossible to be experts in each of the niches and specialties that make up Europe’s thriving tech ecosystem. Yet many who work in venture capital think they have the deep knowledge needed to find and invest in the best start-ups across multiple industries. They don’t.
For more than a decade, tech valuations have ballooned and money has flowed from the seed stage to later rounds. Folders fell last year as funding for European startups increased by more than 150%. Amazingly, 84 of the continent’s 150 unicorn companies have been confirmed in 2021.
But with the volume and value business down, the process of early-stage venture capitalists identifying companies with the best chance of success is becoming more important than ever.
A new reality
It is clear that we are in another world. How do VCs outperform in this new reality? One way is to drop the ego and admit that it is impossible to be an expert in everything. An alternative approach is to find people who have a genuine and demonstrable understanding of a specialized area and work with them.
But where to find them? Here there is good news. There is a network of highly skilled investors with industry expertise in each of the specialties that are making waves in seed investing. They are called angel investors and they represent an untapped resource for VCs.
Often successful entrepreneurs in their own right, these “industry-smart” angel investors are immersed in their subject matter and have a flair for the most exciting start-ups. It is worth knowing them. The current positive environment for angel investing – with the UK having recently reaffirmed its commitment to EIS and SEIS tax relief and the range of funding options available from the European Innovation Council – means the time is right. came for the VC to make friends in the angel. community.
The best angels often fly under the radar, in part because they prefer to keep a low profile. Deals they participate in are less likely to be announced, and if they are, VC involvement and valuations grab headlines. But angels were involved in 28% of all seed-stage deals in the UK in 2020, according to the British merchant bank, reflecting the key role they play in the funding ecosystem. In Britain, angels invest approximately £2.3 billion per year – a significant amount – and are often more resilient to economic downturns than other funders.
To work effectively together, angel investors and VCs need to collaborate rather than compete. It starts with an understanding of what each party can bring to the table. The best angels offer deep industry expertise, market knowledge, and networks that even the most committed VCs don’t have.
VCs, on the other hand, can increase the size of the round, be there to follow with additional funding, and (if they’re good at their job) offer their experience on scaling and team building. To put it in simple terms: By working together, industry smart angels and VCs can build better businesses in partnership with founders who can tap into a bank of knowledge to realize their vision.
Sector orientation is the really important part. This helps validate opportunities for new investors, but also adds post-investment credibility, especially when hiring new talent or moving into larger investment rounds. Having a big name – even if it’s a name that only resonates in a relatively small community – the angel investor can often be the confirmation a more generalist investor needs when writing a big cash check. series B or later.
This is of course easier said than done for VCs. While there are more 38,000 active angel investors in the UK, a relatively small number of them offer the real expertise needed to create value. This is where the importance of building strong networks comes in. And, perhaps, the need for VCs to accept that we can’t be experts in everything.