In The Rise of the Data-Driven Investor Part 1, we reviewed how firms are responding to increasing competition to drive returns through data, yet how many miss the mark on using data effectively to differentiate from peers. In Part 2 of the series, we analyzed ways in which technology can be integrated into deal sourcing workflows, enabling firms to find true opportunities within their areas of specialty instead of running simple filters on millions of companies and doing grunt work on thousands of “targets.”
In the third and final installment of The Rise of the Data-Driven Investor series, we explore how smart use of data can affect firms not only during the initial capital deployment cycle, but also around reserves deployment and investor relations.
Fund allocation strategies are set during initial fundraising, but how to deploy reserve capital depends mostly on “common sense” and high-level data on revenue or user growth. This problem is more evident in venture capital compared to private equity, and the situation only gets worse given VC reserves tend to be higher than those of PE.
Established funds have access to treasure troves of operational data (emerging funds less so, although sector specialization, robust data collection processes, and the use of external data providers typically bridge the gap.) By building sector-specific internal benchmarks and supplementing them with external benchmarks, GPs can get a better handle on how operational metrics can translate into growth levers, and how each lever’s effectiveness changes throughout the years.
Almost every fund-returning asset has had terrible quarters or years. Abandoning “struggling” companies (i.e. anyone not in hyper-growth) instead of helping fix their true growth levers is not something investors can afford, yet it happens every day. Additionally, nearly every investor laments missed opportunities within their own portfolio. According to the power law, missing the right opportunity can kill fund returns. If only we had tracked this seed-stage company more carefully and led their Series A…
Robust portfolio management can provide deeper visibility, and effective collaboration can meaningfully change reserve capital deployment. And even if we put all of this to the side, winning the best deals still comes down to founder references, especially back-channel ones. So there’s still the reputation aspect that can drive returns for the next fund. This is the long game.
As always, investments aren’t the only building block of a successful investment firm. Limited partners are the other piece: along with entrepreneurs, they are a firm’s customers after all! Private capital markets revolve around trust, and trust is built over time. Clearly returns trump relationships, but “top decile” means that 90% of funds (do the math) don’t hit the mark.
When firms collect granular data, make actual sense of it, and then use it to support their portfolio companies properly, they can create real value for their portfolio. How powerful is sending an annual LP update where 15% of total investments previously deemed “0” are now expected to bring 3x returns, partly attributed to specific actions taken by the investor? Probably more powerful than playing around with custom fund performance benchmarks by filtering for vintages and strategies that show the firm in a good light. Power laws can return mega, but consistent support increases the chances of building long-lasting firms.
Besides hands-on portfolio support, firms that have deep awareness of their portfolio benefit during key IR tasks such as sending quarterly reports and responding to ad-hoc LP requests. This is not just a resource-efficiency matter, it’s also about instilling trust around fiscal responsibility. If firms are operationally proficient, they are also more likely to successfully source and win deals, and are likely good stewards of LP capital.
Thank your CFO and finance team, the unsung heroes of every investment firm!
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