The world of finance has already been through some seismic changes. In the 1980s, the Bloomberg Terminal gave Wall Street traders access to real-time data, research, and instant messaging. Everyone in the marketplace could finally talk to each other, it was truly revolutionary. In the 90s, Renaissance was the first hedge fund to bet on mathematical models. That was the start of quant funds.
Venture capital hasn’t changed since it first came on the scene in the 1950s. Some new players have joined the team - micro-VCs, solo capitalists, super angels. But the game has always been played in three sets and the rules are the same: it’s about sourcing as many deals as you can, doing due diligence... basically, doing whatever it takes to close the deal!
This game - half a century old now - has a name: inefficiency. There are a few reasons for that. First, investors rely on their network to source deals. It’s hard - even impossible - for them to cover the whole market.
Second, investment is directly dependent on how much time you have. You can only invest in so many companies.
It’s inefficient, because an investment thesis - assuming you have one - comes with an expiry date. Venture capital theses are a double-edged sword.
Another reason why it’s inefficient is that there is a big asymmetry in market information not just between entrepreneurs and investors, but between investors themselves. Opacity reigns at every level.
And the early stage market is noisy. Over 200,000 start-ups are created in the US every year, and around 50,000 in Europe. Those numbers are impressive, but financial analysts rarely look at those kinds of business, and the rating agencies ignore them.
Finally, if we’re being realistic, it’s not investors that choose the best entrepreneurs, it’s the other way around. The best entrepreneurs pick their investors.
That’s the paradox of the venture capital industry. This is an asset class that’s been phenomenally successful at funding every technological breakthrough for the last four centuries - but it uses no tech itself.
There’s less innovation in the tech funding industry than in construction or education. Maybe because a venture capital fund is first and foremost a collection of personalities that aren’t always coherent?
Whatever the reason, this market’s inherent failures have been great for the best, the funds that have been able to forge a strong brand identity. The venture capital industry is built on the power law principle: not only does a fund’s performance depend on a small number of investors - outliers, but the industry’s overall performance is concentrated in a handful of stakeholders, all of whom have been around for at least 20 years. Who are the losers? Emerging market funds, investment funds that have struggled to consolidate their brand, and finally limited partners, especially family offices, which find it hard to access the cream of the venture capital crop and its returns.
I’m ready to bet that the game I’ve just described will be played on a whole new field within the next five years. Maybe even earlier.
Why? Because artificial intelligence (AI) now has the power to correct the three big inefficiencies in the market: available time, noise, and opacity.
> Available time because, like pretty much every white collar job, venture capital is set for a boom in productivity, in many different roles. Tracking business performance, reading pitch decks, initial contact with entrepreneurs, most administrative tasks, even writing investment memos, support functions for portfolio firms, all of that will be reorganised and simplified by AI.
> Noise, because that’s where the first wave of disruption will hit. Eliminating noise is like trying to find a needle in a haystack. The ones who can do it will be the big winners in the future. SignalFire, Tribe Capital, and 2.12 Angels are the best examples.
> Eliminating opacity will be the second wave of innovation (and we already have a snapshot of that with AngelList). A Bloomberg Terminal-style revolution will introduce transparency into the marketplace. Everyone will have access to information on deals. Signal, NFX, and Harmonics.ai. are the pioneers in that area.
As a result, the playing field could open up to other stakeholders, not just VC funds, which would be a game-changer for family offices.
