Data-driven investing: fixing fundraising inequality
When it comes to fundraising for startups, inequality is a massive problem. Investors have traditionally held a narrow view on what a viable investment looks like. Founders need to check a number of boxes not only for their company, but for themselves: Their educational pedigree, personal background, family and personal connections, hobbies, and even appearance. More often than not, founders who get funding look a lot like the investors who fund them. In practice, this means that more than 75% of all fundraising rounds go to exclusively White founding teams. In 2019, only 2.8% of all capital invested in US startups went to companies founded by women.
I am a first generation Hungarian and one of my two co-founders is Latin American. While we have not experienced the depth of issues that exist, we understand what it feels like to not check all of the traditional boxes. It’s not only a founder’s background that often determines their funding; it’s also their location. With 28% of the US’s venture capital firms headquartered in the San Francisco Bay area alone, geographical inequality is its own force to be reckoned with.
According to StartupBlink, the same five cities have hosted the largest startup ecosystems for at least the last three years: San Francisco, New York, London, Boston, and Los Angeles. Investors flock to regions that are startup-heavy, as it’s easier to manage many investments that are geographically proximate. This means that 77% of all portfolio companies in the US are in San Francisco, Boston, New York City, Chicago, Los Angeles, Washington DC, and Seattle. Only 23% of venture-backed startups are elsewhere in the US.
If your company is in the right zip code, your odds of receiving funding are substantially higher. This is because investors and entrepreneurs are still fundraising as if it were the pre-internet days: networking events, in-person meetings, and traditional pitches. When investors are only interested in founders they can meet and companies they can visit, anyone outside of a major investment hub will struggle to get funded.
But COVID-19 means no more in-person meetings and networking events. In a world of social distancing and mandated lockdowns, where you live and who you can be connected to within driving distance is meaningless. An investor in Cincinnati can just as easily meet with a founder in Tel Aviv as they can a founder in their own city. Whether potential investors are next door or around the world, the option to meet in-person no longer exists.
Investors need a new way to vet companies and allocate funding, without the luxury of meeting face-to-face. While software such as Zoom can provide a comfortable stop-gap, the real solution is to tackle fundraising inequality head-on and stop limiting investments to companies in preexisting startup hubs. As someone who has invested in companies outside of the major hubs — in cities like Sydney, Tel Aviv, and Budapest — I can promise you that there is great value in investing elsewhere. Expanding beyond the traditional startup hubs and the traditional picture of a startup founder can give you access to thousands of startups that others are overlooking.
Right now, investors have to be resourceful. Instead of relying on interactions with founders, we should rely on what we still have access to in the age of COVID-19: Data.
The Solution: Data-Driven Investing
By switching fundraising from relationships-driven to data-driven, investors can evaluate potential companies by the metrics they produce. The person behind the company and the company’s location will matter less than what the company has proven itself capable of.
Consider Lending Club, a company that offers peer-to-peer personal loans. The investors behind these loans are only given objective information to evaluate their investments, including risk level, credit score, and debt-to-income ratio. Lending Club investors never meet those they invest in, nor can they evaluate them by anything but the data.
While investing in startups is more complex, the core concept remains. Investors should be given access to as much hard data about a company as possible to evaluate the company’s health and potential. Relationships and physical proximity should be an afterthought to data-driven investing.
The ideal platform for connecting investors and entrepreneurs would pull a company’s data directly from the source, giving investors access to reliable and up-to-date data. Investors could, at any time, monitor the success of the companies they invest in, without waiting for updates from the founders.
For investors, this means better accountability in their investments; for fundraisers, this means less friction in getting funded, as they only have to connect their recordkeeping systems to the service to have their data shared with investors. This approach is especially advantageous in a post-COVID-19 world where a company’s past track record may not necessarily reflect its current and/or future performance.
With access to such a wealth of data, networking will no longer be the method by which investors determine their investments, leveling the playing field for companies that are located too far from major investing hubs or who are less well-connected.
A data-driven system will also make it easier for investors to find relevant companies to invest in. The program could optimize for an investor’s preferences, suggesting similar companies to invest in based on the investor’s risk profile and what holes they may have in their portfolio, much like how Netflix learns your preferences and proposes content that suits them. Instead of relying on suggestions from those in their preexisting network, investors could connect with their ideal companies from all around the world, no introduction needed.
The trend towards digitizing business existed prior to COVID-19, but has now been accelerated irreversibly. By removing physical proximity and personal relationships as the primary drivers in funding, more companies will be able to access funds and more investors will be able to connect with companies they want to fund. COVID-19 is a catalyst, but the great equalizer of data-driven fundraising will last far beyond the pandemic.
Thinking about fundraising? Sign up for a free account on Hum’s Intelligent Capital Market, and learn what kind of financing your company might be qualified for today.