Venture capital deals come in many forms. You might tend to think about Silicon Valley and all the startups that have sprung up there. You might also imagine all the famous people who have used their name to rake in millions. Despite all the scenarios you could imagine, there are really only three strategies, and these are derived from the same goal. That goal is to expand or add to the distribution in a company in some way that results in explosive growth.
There are three ways to accomplish this, namely: improved sourcing, value adding and better investment. Ideally, a good plan will involve all three of these activities. There are other things involved, but they should all contribute to these three objectives. Any tactic that doesn’t further these goals in some way are nonsense or marketing ploys.
The investing activities of most VCs are actually quite random, which could result in either good or bad investment funds within short periods of time. However, over longer time periods, the mediocre investments will start to reveal themselves by having weak persistence in performance.
How does adding value work?
Adding value is accomplished in a variety of ways by the investor. The most common tactic is to improve company operations. This can be done in many ways including partnership, recruitment, board support and selling. A venture capitalist (VC) can accomplish this by coaching the company owners or even by getting more directly involved in day-to-day operations and management.
Companies can also increase value through the implementation of software platforms or technical teams. There are specialized startup studios that sit between the roles of company owners and investors. These teams have made unique contributions to the venture capital industry. In any venture capital deal, value adding is essential because it validates your commitment to be a partner with the company founders.
It’s vital to improve sourcing
The role of the VC should be to improve the scale of the company. When the VC fund portfolio consists of companies that have improved sourcing, its investment returns are higher than average.
One way to improve sourcing is to improve the network. This helps companies with good reputations and people who are exceptionally talented in their industries. Another example is if a company can become dominant in a particular region of the global industry.
Early-stage companies often ignore the potential of outbound sourcing because there are so many inbound referrals. If VCs target truly exceptional company founders, this strategy can be implemented more effectively.
Company owners tend to look for VCs who have invested with exceptional startups because it demonstrates the VC’s experience in the industry and proves their ability to scale a business. It shows that they have been involved in exciting ventures in their early stages.
In the initial stage of investing, the key strategy is picking the right companies. This mostly is accomplished via good judgment, but this quality is hard to define, and it can only become apparent over time.
Good investing also comes about through research and development. One way to gain insights is to develop an industry thesis that enables you to make predictions on economic and technological trends. Accurate predictions lead to more wins in the market.
Choosing investments is both an art and a science, and neither of these aspects are easy. That’s why the performance of investors at any individual firm varies so much. In order to improve your judgment, you should always test your ideas and strive to improve your decision-making ability. You should bounce your ideas off of your colleagues, do a lot of reading and be critically self-reflect on your past performance.