Thoughts on quant approaches to early stage investing

By August 15, 2013Venture Capital

‘Quant VC’ is a hot topic at the moment. Techcrunch and VCs have been writing about it, VC funds have been hiring data scientists, and Kleiner Perkins has taken the step of branding its proprietary data mining tool as Dragnet. There is even a company called Mattermark with the tagline ‘Big data meets venture capital’.

All of this activity is happening for the same reason as in many other industries: there is now a lot of data that can be used to support decisions. Data sources to be mined include AngelList, Crunchbase, VentureSource, the App Store, the Google Play Store, the Facebook Platform,  Klout scores, Twitter mentions, LinkedIn.

There’s a lot of good insight to be drawn from this data, but nobody (with the possible exception of Mattermark) is saying it’s possible to build a predictive model that estimates a startup’s chances of success. That’s mostly because the world is changing too fast. Startup success generally takes five to seven years but technology and markets have moved on too far for repeating a formula that worked five years ago to make sense. 2006-2008 was a mini-bubble period where gen 1 social networks Bebo, Myspace and Facebook were the big story and investor interest in business models was at an all time low.

So rather than predicting success the data is used to support decision making by surfacing trends and prospective investments and for analysing competition.

  • Kahneman’s Thinking Fast and Slow is a must read for discussions of decision making in conditions of extreme uncertainty. He outlines a simple scoring system that he used for officer training selection. In that example, he found combined quantative approaches and intuition produced the best results. It’s applicable to a wide range of problems, although it’s only a foundation.

  • Thanks Ben. Thinking Fast and Slow looks good. There’s a copy winging its way to my Kindle now.

  • Isn’t 500startups to a degree taking this approach? Not to speak for them, but I believe their premise is that precisely because it’s impossible to predict, don’t try. If a start-up displays some minimum set of critical characteristics (ie good team, hot space, relevant skills/experience in the space) they invest a small amount at what they believe to be a reasonable valuation without a lengthy (and thus expensive) analysis. Then, don’t invest a lot of expensive time nurturing, rather just see which ones survive and double down. No way a priori to know which of the 500 hundred will hit it big, but some will.

  • Hi Ed – I think the better way to think of 500 Startups is as investing in the market rather than a quant play. They invest in a large number of companies but don’t use numbers to drive their decision making (particularly).

    At the next level of detail – despite their marketing they are still stock picking in the same way as most VCs and on similar criteria. The difference is that they are choosing to invest in a higher percentage of the companies that they see at an earlier stage with less cash.

  • truthflux

    I’m surprised you haven’t already read it. It seems right up your street.

  • Too many books. Not enough time 🙁

  • stephen
  • Thanks Stephen. I’m about to send you an email.