Innovation in Venture Capital
Submitted by: Abdullah Mert Akman
Supervisor: Prof. Dr. Isabell M. Welpe
Here is the link to the Notion page of the thesis.
Purpose
This study examined the main trends that venture capitalists should follow today and in the coming years; in addition, it examined the importance, characteristics, and impact of each trend. Throughout the study, these trends were grouped under four main headings: money, green, database, and entrepreneurship. These trends, which venture capitalists should follow, are examined in detail. Cryptocurrency, Zebras, Fractional CFOs, and portfolio distribution are explained in detail under the heading of money trend.
Next Trends of Venture Capital in 21st Century
As a result of the research, four popular topics were found where VC and innovation intersect. Money, green, database, and entrepreneurship-based trends were examined, respectively. Each trend is a general set of the fastest-growing areas of the last ten years.
Cryptocurrency, zebras, new alternatives, fractional CFOs, and portfolio distribution are examined in detail under money trends. While the concepts of cryptocurrency and zebras have been the most popular money trend titles in recent years, their popularity has increased more recently, although the others are older titles.
Sustainable investment has become one of the most important agenda items of VCs after the steps taken by governments, and together with Cleantech, they have become the most popular area of green trends.
The importance of big data has increased very rapidly and continues to increase, but all institutions are experiencing great difficulties in the analysis of this data. VCs are also trying to improve themselves in this area. Algorithms and alternative data fields offer a new perspective for VCs.
Entrepreneurship-based trends are one area where VCs are evolving to focus on the right startup. Being a pioneer, using marketing, and benefiting from diversity are examined under this title.
Money Trends
The year the cryptocurrency gained popularity was 2017. Until that year, only a small minority of VCs were investing in this space. With the rapidly increasing popularity of this field, VCs have also tended to this field. Venture capitalists are creating portfolios in which they include blockchain technologies or have started investing directly in companies with blockchain technology. The most important reason for this situation is undoubtedly the liquidity and financial flexibility offered by crypto assets.
Zebras are companies that exhibit traits that are the opposite of unicorns. After many unsuccessful attempts, born with the Unicorn dream, the orientation towards Zebras increased rapidly. In these days, when endless growth is losing its appeal, the importance of zebra startups like BaseCamp is increasing day by day because these companies think that money earned from the same place is more important than making money from everyone. Entrepreneurship ecosystems are now hosting more quality-oriented startups, and this seems to lead to major changes in the areas where VCs invest in the coming years.
The expectations of VCs from startups have also changed over time, and new alternatives are frequently discussed.
Fractional CFOs have become one of the most critical needs of startups lately. Knowing the right CFOs makes it easier for VCs to invest in the right startups. A fractional CFO has many positive effects on a venture, and these effects are the best answer to why you should work with a fractional CFO. First, CFOs play an essential role in developing long-term strategies. The basis of this strategy is the financial model, which is always well-founded. Often, founders have insufficient knowledge of many important key factors, from basic information such as profit and loss that the company has to more functional information such as marketing forecasts, growth plans, and customer churn. Being able to predict the income and expenses of companies in the most accurate way and having a model that uses it is important for more than just keeping the existing business in this world where SaaS is widespread.
Portfolio distribution is an issue that has been discussed frequently since the middle of the 20th century, and it is still an issue that is not clear what the correct solution is. In an area where working with the right fund managers is also insufficient, many VCs make less money than they invest. Only a small portion of investments yield large returns. For this reason, venture capitalists should have a much wider investment portfolio instead of investing in 3-4 places, which is a classic mistake they make when investing.
Green Trends
VCs who care about sustainability place more value on two main issues. They invest in initiatives that address environmental and natural challenges and significantly impact society, such as education and health.
ESG factors are the basis of sustainability. These factors are an accurate measure that startups can use to show venture capitalists that they genuinely care about the environment and nature. There are seven issues that venture capitalists should do in this regard and according to ESG factors. These are management, risk management, materiality, impact technology, monitoring, value creation, and proportion.
There are many areas for venture capitalists to invest in sustainability. In fact, many new opportunities are presented to investors every day. There are many challenges to sustainability. The most obvious of these are geographical, political, and cultural influences.
Sustainable investment is an ideal investment considering the features a venture capitalist cares about. Likewise, the person who can best meet the needs of a sustainable and environmentally friendly project is a VC. Generally, a VC investment is relatively long-term, and a sustainable project is a longer-term project than expected.
Cleantech companies emerged after the dot com event and were not the cornerstone of almost any portfolio company at that time. It was simply an area with great potential for many investors. At this point today, although it is a sector that brings low returns despite very high risks, it is close to being one of the rare remaining areas in the field of investment. The biggest proof of this is that one of every three venture capitalists invests in projects that contribute to nature.
Database Trends
Like every process in science, there may be a mistake in AI processes, and this mistake may be that artificial intelligence makes completely unbiased and rational decisions. The biggest proof of this is that nothing about machine learning was created in a vacuum. The people who created these structures are people who are proficient in statistics and computer science.
The biggest positive aspect of alternative data is that it does not have a negative side about what it can gain. It provides information that can be used as a direct supplement for VCs, and thanks to this information, it provides a supporting factor in making a more accurate decision.
With machine learning, four main problems may arise in data analysis, and these problems may cause the performance to appear higher than it is. Additionally, there is a definite human influence, and it is quite possible that there will be errors in the technologies that come with AI.
Defining a hybrid approach and making the right decisions by including data systems in the decision mechanism seems to be the primary goal. This actually reveals a decision mechanism that includes many indicators. Many different parameters such as vision and team integrity, proximity to entrepreneurial ecosystems, technology dominance, market size, and sales strategy can be included in machine learning by the experts of this business by putting certain prejudices.
The increased frequency of algorithms puts many traders' teams in a useless position. For this reason, experts in investment show very high resistance to algorithms. They provide evidence that thinks the algorithm will never be enough. In fact, it is still challenging to find an optimal balance between the algorithm and the experts; both have flaws and need support from each other.
Big venture capitalists such as 645 Ventures, Connetiv Ventures, and Ardian have rapidly increased their support for artificial intelligence and machine learning, considering that new investments should be made in this data.
Entrepreneurship Based Trends
As the number of venture capitalists increased, the need to reach the right VC entrepreneurs arose over time. Entrepreneurs are left alone for a long time after receiving financial support, and this is one of the main reasons for failure. This has led many entrepreneurs to evaluate VCs from different perspectives.
Many institutional mutual funds and venture capitalists dedicate more time to early-stage companies that they have not paid much attention to for a long time. Companies that received investments in the seed and Series A stages are now able to make a name for themselves in the entrepreneurship ecosystem. All venture capitalists have a similar mindset: the desire to spot and invest in a startup that will become a unicorn before it even rises or to move forward by investing in many undervalued companies instead of money to be given to companies with inflated valuations.
Companies that are new to the entrepreneurship and investment ecosystem have two paths to diversify. The first is to accept the status quo without disturbing the existing order. The second is to be one of the leaders of this change in diversity and to have a share in the success of teams that respect all diversity over time. This success will not be immediate, but the 21st century seems to be an essential period for this change.
Characteristics of Innovative VC Firms
Innovative venture capitalists have three main characteristics in common. First, they often consider extremely high-risk investments as usual. Investing in potentially high-return startups comes with high risk. Second, they often focus on early-stage companies. In addition, the value placed on the idea and the team is higher than the financials. This means that venture capitalists are interested in investing in startups and want to impact their success significantly. Third, it usually focuses on a particular industry or sub-sector.
Conclusion
Venture capitalists pursuing innovation also face more significant risks than regular VCs. For this reason, it is no longer sufficient for VCs to only direct and contribute to innovation, but it is also necessary for them to adopt and adapt to innovation. VCs today focus on developing their teams in this area, but they still have many more steps to take. In many aspects of money trends, VCs have lagged behind and are trying to catch up with these trends with quick steps. Although green trends are an area that a specific section of VCs has previously adopted, it is a type of trend that more VCs are trying to catch up with and struggling to stand out, as governments' investments and regulations in this area are more serious. Databases and algorithms are the foundation of analytics capability, and big data has never been more critical. This is undoubtedly a reality for both academia and the private sector.