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When Will the Robots Take Over Venture Capital?

Source | LinkedIn : By Ryan Caldbeck

In public market investing, the robots have taken over — and in many ways, that’s a good thing. When will private company investing follow suit?

The stock market was once dominated by brokers crunching numbers and doing deals at physical finance hubs such as Wall Street. Today, computer-automated “quantitative funds” are doing much of the analysis, buying, and selling that humans used to do — and are quickly eclipsing their analog predecessors.

According to Bloomberg, quant funds have doubled over the past decade to control some $500 billion in assets. Even firms focused on traditional “fundamental” trading practices are increasingly incorporating computer automation into their workflows.

There are many upsides to this new approach: Purely data-driven investing is more efficient and often more successful than traditional stock investing methods centered primarily around human judgement and relationships. They can be more meritocratic, too: Quant investing focuses purely on numbers and performance, without the social biases and over-reliance on personal connections that often surfaces when people do business.

A Growing Trend, but a Shrinking Sector

But quant investing is a growing trend in a shrinking sector. The number of companies listed on public stock exchanges in the U.S. has plunged 46% over the past 20 years, from more than 8,000 in 1996 to around 4,300 in 2016. Meanwhile, the quantity and quality of private companies has blossomed. Increasing government regulations for public companies coupled with the stock market’s potential for volatility have compelled many successful and growing companies to stay out of the public markets altogether.

This growing private market has not seen the rise of the robots quite yet. Deals in this area are still largely done with a human touch: Analysts comb through data to compile information, due diligence is done through a series of phone calls and in-person meetings, and investments are finalized with a handshake and a wire transfer. While there are nearly 30 million private businesses in the United States today, there’s virtually no standardized technology used to optimize private equity investing.

The Data Gap

Why is private equity so far behind its public market counterparts when it comes to data-driven investing? For one thing, there is a lack of clear data to crunch.

The public market has an abundance of clean, structured data that can be used to predict company performance: The SEC requires that public companies disclose precise information about sales growth, revenue, profits, employee headcount, and more on a quarterly basis in a format that’s accessible to the general public. The rise of relatively cheap processing power means that computers can obtain and analyze this data faster than ever before. In addition, third party data providers that structure data for public investors (including quant funds) to digest easily have existed for many years.

This kind of information is much less readily available from private companies. One of the biggest perks of the private market is, well, the privacy: the ability to grow away from the glare of the public spotlight. Private companies generally only share key data — revenues, user numbers, profits, growth — with their existing investors.

This creates a chicken-and-the-egg scenario: In order to create a data-oriented investing fund, you need access to data. But historically, the only truly reliable way to obtain valuable data about a private company is to become an investor in it. Additionally, quant funds by definition require powerful technology infrastructure, which can only be built through a significant investment of time and resources — both of which upstart firms typically don’t have.

Read on….

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