Should VC investors pick a lane and stay in it?
September 21, 2024
"Stay in your lane" is a phrase that, once you look past the condescending overtones it can occasionally be delivered with, may well offer some worldly wisdom.
Developing worthwhile expertise in a domain often requires a disciplined and focused effort.
In VC investing, this phrase applies to the much-argued generalist-versus-specialist debate, particularly as it relates to the scope of technology verticals included in an investor's investable universe.
Specialists believe that a deep understanding of a narrow set of markets and technologies enables them to better assess a startup and its founder's prospects. On the other hand, generalists argue that there are many commonalities in analyzing startups across tech verticals and that the increased flexibility allows them to be nimbler when opportunities arise.
To help settle this debate, we took a data-driven approach to answer the question: Should VC investors pick a lane and stay in it?
To answer this, we performed an analysis of VC deal outcomes that were split into two groups: deals where the lead investor had high domain expertise in the target company and those where the lead investor had low domain expertise.
Domain expertise was based on the degree of similarity between a target company and VC-backed companies that the lead investor had previously invested in.
Given the complexities involved in quantifying similarity between pairs of companies, we employed an open-source LLM trained on massive amounts of data to understand both natural language and semantic similarity. We then fine-tuned this model on VC-backed company descriptions in the PitchBook Platform.
Our key finding was that companies in VC deals where the lead investor had high domain expertise had a 1.2x greater probability of a successful exit (acquisition or IPO) than those where the lead investor had low domain expertise.
However, the answer to the original research question was not as straightforward as that finding would suggest. In particular, we found that the apparent advantages of domain expertise varied meaningfully across verticals.
The AI & ML and fintech verticals stood out as two exceptions to the conclusion that domain expertise has been associated with better exit outcomes. On the other end of the spectrum, the results suggest that domain expertise is especially important in the healthtech and pharma verticals.
For a more detailed explanation of the methodology and additional findings, please download our free analyst note:
Should VC Investors Pick a Lane and Stay in It?
Developing worthwhile expertise in a domain often requires a disciplined and focused effort.
In VC investing, this phrase applies to the much-argued generalist-versus-specialist debate, particularly as it relates to the scope of technology verticals included in an investor's investable universe.
Specialists believe that a deep understanding of a narrow set of markets and technologies enables them to better assess a startup and its founder's prospects. On the other hand, generalists argue that there are many commonalities in analyzing startups across tech verticals and that the increased flexibility allows them to be nimbler when opportunities arise.
To help settle this debate, we took a data-driven approach to answer the question: Should VC investors pick a lane and stay in it?
To answer this, we performed an analysis of VC deal outcomes that were split into two groups: deals where the lead investor had high domain expertise in the target company and those where the lead investor had low domain expertise.
Domain expertise was based on the degree of similarity between a target company and VC-backed companies that the lead investor had previously invested in.
Given the complexities involved in quantifying similarity between pairs of companies, we employed an open-source LLM trained on massive amounts of data to understand both natural language and semantic similarity. We then fine-tuned this model on VC-backed company descriptions in the PitchBook Platform.
Our key finding was that companies in VC deals where the lead investor had high domain expertise had a 1.2x greater probability of a successful exit (acquisition or IPO) than those where the lead investor had low domain expertise.
However, the answer to the original research question was not as straightforward as that finding would suggest. In particular, we found that the apparent advantages of domain expertise varied meaningfully across verticals.
The AI & ML and fintech verticals stood out as two exceptions to the conclusion that domain expertise has been associated with better exit outcomes. On the other end of the spectrum, the results suggest that domain expertise is especially important in the healthtech and pharma verticals.
For a more detailed explanation of the methodology and additional findings, please download our free analyst note:
Should VC Investors Pick a Lane and Stay in It?
Andrew Akers, CFA
Senior Quantitative Research Analyst
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