Venture capital investing is not for the faint-hearted. Fierce competition exists within the VC industry as investors hope to land the next unicorn company. With an industry standard of three out of four venture-backed companies failing, the stakes have never been so high….

Investing is a personal decision, so every investor approaches it differently. Nevertheless, all venture capital investors are attracted by the same thing; a solid return on investment accompanied by a lot of interest and capital growth.

Today we look at some of the biggest challenges faced by venture capital firms, having awareness and an expectation of these potential pitfalls gives you a leg-up over the competition enables budding investors to make the best decisions possible….

Keeping Up With The Competition

Competition is a constant presence in almost any industry, and venture capital is no different. A common gripe for venture capitalists is feeling like they’re almost always the second choice in comparison to the major players in the industry such as Sequoia, Accel or The Blackstone Group -who recently made history with a buyout fund topping $26 billion.

After all, why should anyone go with you? Each of these investment firms has great reputations, great deal flow, and most importantly, incredible realized returns based on actual exits over marked-up predictions.

Limited Partners (individuals who provide venture capital firms with capital) generally only want to invest in the top two or five proven venture capital firms, for a variety of very good reasons.

This raises several points of contention for LPs;

  • The top firms can only accommodate perhaps 5% of the capital that the LP wants to invest;
  • LPs, even with the right capital, often fail to break into the “top” 2-5 companies.
  • Cambridge data indicates that only 1-2 partners at most VC firms are responsible for most of the returns. Which makes the definition of a partnership somewhat of a myth; since returns concentrated among usually 1 or 2 key general partners.

How VC & PE Firms Are Tackling The Rising Competition

Software

Today you can find a proprietary SaaS application to streamline almost any process, and venture capital is no different.

The power of AI and Machine Learning have allowed venture capitalists to gain a competitive advantage.

Software such as InReach Venture’s “DIG” provides an extensive database of over 95,000 start-ups as well as combining data aggregation, AI, automated proactive outreach, and scalable workflow management. Resulting in a far more scalable, efficient, and informed method of investing in start-ups bound for success.

Another notable SaaS application making waves in the VC space is EQT Ventures’ Motherbrain which is revolutionised the process of tracking and prioritizing leads. Savvy use of saas applications can help tackle venture capital issues and challenges like never before.

In-House Specialists

This is nothing new – it can often be the secret weapon for VC to propel a start-up to success.

VCs can have significant say in the day-to-day running of a business and it’s not uncommon for entire teams of specialists to be brought in-house. 

This allows start-ups to benefit from timely access to and support in fields such as Software Engineering, Marketing, Product, Design, Communications, Business Intelligence, Sales and Customer Success, and Organizational Building.

This is among the key strategies for VCs to increase start-up success odd’s, and the resulted are undeniable when conducted correctly.

You’re Overpaying And You Have No Choice

The concept of start-up overvaluation is no longer as rare as it once was. As the world of technology and SaaS expand at an exponential rate the number of rising start-ups and potential unicorns has skyrocketed along with it. This funding frenzy has sparked the conversation of a potential “VC Bubble” looming.

Many are starting to realise that these so-called unicorn start-ups, much like their mythical counterpart, are not real. More often than not these companies fail to reach their astronomical valuations after entering the fiercely competitive market. Let’s be clear here, overvaluation can have detrimental effects on founders as well as their investors.

Needless to say, the potential risk to revenue from overvaluation is significant and should aim to be avoided, moreover; LPs are not giving VCs millions of dollars just to sit in cash and be charged 2% a year. It’s a bad model. This is a concern that should be thoroughly considered through due diligence cycles.

All areas of investment can be impacted by FOMO (fear of missing out); so much so that it’s common for hype and pressure to shorten due diligence from weeks to days when in actuality this is the area that should be given utmost care and consideration.

Lack Of Visibility of Portfolio Performance

One of the biggest challenges faced by venture capital firms is the lack of visibility regarding portfolio performance. This has begun to change with many software’s attempting to tackle the problem of portfolio reporting, however, it’s not yet an air-tight process.

The timeframe for a VC fund in conservative estimates can range between 6-8 years before tangible results are visible. Missing, inaccurate, or inaccessible data can also hinder performance visibility.  

Whilst software still has a way to go before providing complete portfolio control at your fingertips there are actionable measures venture capitalists can take today to enhance data integrity, simplify investor reporting, and allow you to make data-driven decisions. 

Data silos and missing data can be resolved by integrating systems and integrating data into a single source. Inaccuracies in your data can be corrected by establishing data governance guidelines and procedures. Additionally, a user-friendly enterprise data portal allows investors to access the data they need in a timely manner.

Venture capital advantages and disadvantages are multifaceted – we hope this article has assisted you in navigating the minefield and making the best investment decisions possible sign up here to stay up to date with all the latest VC News & Content!

Written by James Coffey

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