Why VCs can’t be experts all the time

To properly understand the vast array of early-stage technology businesses pitching for funding today, venture capital investors require a breadth of knowledge that is almost impossible to comprehend. 

A recent report by the Spanish bank BBVA identified 14 distinct tech neologisms to have emerged in recent years, each one offering opportunities for investors but also necessitating a deep understanding of a specific industry, market or technology. And these 14 categories, including fintech, cleantech and biotech, are only the ones that have made it into the mainstream. There are many more subcategories. 

The Truth

The truth, of course, is that it is impossible to be experts in each of the niches and specialisms that make up Europe’s thriving tech ecosystem. Yet many working in venture capital believe they have the deep knowledge required to find and invest in the best early-stage companies across multiple sectors. They do not.

For more than a decade, tech valuations have swollen and money has flowed from seed stage through to later rounds. Records tumbled last year, with funding to European startups growing by more than 150%. Staggeringly, 84 of the continent’s 150 unicorn companies were confirmed in 2021. 

But with the volume and value of deals now falling, the process for early-stage VCs of identifying the companies with the best chance of success becomes more important than ever. 

A New Reality

It is clear we are in a different 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 do have genuine, provable understanding of a specialist area and work with them. 

But where to find them? Here, there is some good news. There is a network of highly knowledgeable investors with sector-specific expertise in each of the specialisms making waves in early-stage investment. They are called angel investors and they represent an untapped resource for VCs. 

Often successful entrepreneurs in their own right, these “sector smart” angel investors are immersed in their subject and have a nose for the most exciting start-ups. It is worth getting to know them. The current positive environment for angel investing – with the UK recently reaffirming its commitment to the EIS and SEIS tax breaks and the range of funding options available from the European Innovation Council – means now is a great time for VCs to make some friends in the angel community. 

The best angels often fly under the radar, partly because they prefer to keep a low profile. The deals they participate in are less likely to be announced and, if they are, VC involvement and valuations take the headlines. But angels were involved in 28% of all UK seed stage deals in 2020, according to the British Business Bank, reflecting the key part they play in the funding ecosystem. In Britain, angels invest about £2.3 billion a year – not an insignificant amount – and are often more resilient to economic downturns than other funding providers.

To work effectively together, angels and VCs must collaborate rather than compete. That starts with an understanding of what each side can bring to the table. The best angels offer deep sector expertise, market knowledge and networks that even the most committed VCs do not have. 

Working Together

VCs, meanwhile, can increase the size of the round, be there to follow on with extra funding and (if they are good at their jobs) offer their experience on scaling and building teams. To put it in simple terms: By working together, sector smart angels and VCs can build better companies in partnership with founders who are able to draw on a bank of knowledge to realise their vision. 

The sector focus is the really important part. It helps validate opportunities for new investors, but also adds credibility post-investment, particularly when hiring new talent or moving on to bigger investment rounds. Having a big name – even if it is one that only resonates in a relatively small community – angel investor can often be the confirmation a more generalist investor requires when they write a big cheque in Series B or later. 

It is, of course, easier said than done for VCs. While there are more than 38,000 active angel investors in the UK, a relatively small number offer the true, value-enhancing expertise required. That is where the importance of building strong networks comes in. And, perhaps, the need among VCs to accept that we cannot be experts in everything.