First Stage Investor

Don’t Look Backwards In Startup Investing

Don’t Look Backwards In Startup Investing
By Andy Gordon
Date June 10, 2021

Over the past five years, the top 25 venture capital (VC) firms invested in around 1,600 early-stage startups

According to CB Insights, the sectors with the biggest increase in investments from VCs are fintech, enterprise software, enterprise analytics, pharmaceuticals, consumer apps, renewable energy and media. The sectors that have seen the biggest decrease are consumer on-demand, sales and marketing software, direct to consumer, digital health and cloud storage products. 

I’m not going to analyze these sectors. I’m sharing this information with you as a sort of warning. 

These lists seem authoritative. As CB Insights puts it, “Many of the game-changing startups of the 2020s will likely emerge from the portfolio companies of these firms, making this list a powerful filter for uncovering startups and industries.”

Sorry, but I disagree. I don’t put much stock into these lists. 

First and foremost, they’re backward-looking. What I mean by that is these investments were made in a market that doesn’t exist anymore. Technology, markets and consumer behavior change rapidly. A list of VC investments from five years ago doesn’t say anything about today’s investing landscape. 

I’m much more interested in learning about the rising sectors of this year — or of the next five years. And I’m willing to bet that a couple of the recently fast-rising sectors will reverse course in the next five years. As far as I’m concerned, CB Insights’ list is ancient history.

Take digital health for example. Five years ago, the sector was new and exciting. Everyone predicted that digital healthcare was the way of the future. While that remains true, the sector is not as exciting now as it was then. CB Insights added it to the list of sectors that have seen a declining number of investments. 

But with COVID-19 sparking an explosive telehealth trend, insurance companies now cover many more digital healthcare services than they did pre-pandemic. Things are looking up. 

But CB Insights’ list — because it’s backward-looking — doesn’t reflect this positive shift.

This issue extends to the top 25 VC firms themselves. These firms were ranked according to the past five years. The top 25 firms five years from now will be different. New VC firms will be added to the list and others will be removed. If you made investment decisions based on this list, you’d be following the lead of at least some VC firms with less-than-stellar track records. It doesn’t make sense. 

Another big problem: In five years’ time we’ll have a much better idea of how many big winners have emerged from these sectors. But right now we’re just counting VC deals made. It could turn out that some of the sectors that declined in popularity during the past five years will generate big winners. We just don’t know. 

Most of all, I don’t like these lists because they don’t fit with my approach to early-stage investing. 

I’m sector agnostic. A great startup is a great startup. I don’t seek out startups from particular industries. 

But many VCs do. They first choose the sectors they like and then identify the best investment opportunities in those sectors. It allows them to concentrate resources, build sector expertise and develop networks where they’ll be doing most of their deal-making. 

But what makes the most sense for VC firms doesn’t necessarily make sense for crowdfunding investors. 

We have the entire spectrum of sectors to invest in. This wide-ranging deal flow is one of the best features of crowdfunding. I can invest in any number of startups from any sector I choose.

A startup from an obscure corner of the economy could be my next big winner. Why restrict my choices when I don’t have to?

In the future, I’ll address the broader question of whether crowdfunders should be paying attention to anything VC firms do. As crowdfunders, we do things differently. And in most ways, we’re better off for it.

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