By Tiana Laurence, partner at Laurence Innovation, a pre-seed investment fund focused on early-stage tech companies in the 4IR verticals.
We’re witnessing a dramatic period of technological change that will permanently alter how we interact with one another and the world around us. With the rapid proliferation of companies that focus on technologies like artificial intelligence (AI), quantum computing, blockchain and biotechnology — what’s often referred to as the Fourth Industrial Revolution (4IR) — many venture capital (VC) investors are trying to figure out which of these companies are innovative and sustainable enough to warrant an investment.
However, far too many VC firms are still stuck with antiquated investment strategies that aren’t keeping pace with the increasingly dynamic and tech-driven global economy, primarily the dissemination of information. There are many reasons traditional VCs miss opportunities to fund revolutionary and profitable companies — from conservative, risk-averse investment strategies that fail to consider a broad enough range of promising investments to biases toward companies in specific, narrowly defined industries and founders who look a certain way.
It’s vital that VCs don’t conflate “risk-averse” with “prudent.” With so many unprecedented opportunities to find alpha as the Fourth Industrial Revolution continues to pick up momentum, investors should build their strategies around developing large and diverse portfolios that maximize the chances they will partner with groundbreaking companies. This won’t just help them increase their returns — it will help them change the world.
4IR Companies Are Addressing The Biggest Problems We Face
Many people associate the development of new technology with consumer goods — better smartphones, new software and so on. While these products have a significant impact on economic growth and our quality of life, they only represent one aspect of the fundamental technological shifts that are taking place. As the World Economic Forum explains, 4IR is more than an opportunity to increase the bottom line for tech companies — it’s an opportunity to “harness converging technologies in order to create an inclusive, human-centered future.”
It’s no surprise that investments in 4IR have been steadily increasing, but these investments have coincided with a different phenomenon: an emphasis on social responsibility. A Deloitte survey of C-suite executives found that “societal impact” was by far the “top factor used to measure success when evaluating annual performance.” The report observes that this ethos is integral to the mission of 4IR companies: “For many companies born at the dawn of Industry 4.0, the societal impact has been woven throughout the fabric of their organizations from day one.”
These are all reasons VCs should be looking for companies that aren’t just innovative and financially sound — they should invest in companies that have a clear vision for how they will make the world a better place. This isn’t as dreamy as it sounds — consumers’ purchasing decisions are increasingly driven by their perceptions about a company’s stand on social and environmental issues, so mission-driven companies are in a stronger position to capture market share than their neutral peers.
Developing The Right 4IR Investment Strategy
It makes sense that 4IR companies are ahead on trends like the emergence of belief-driven buyers and corporate social responsibility (CSR) — they’re building new products and services around technologies that have vast implications for the improvement of human well-being. But considering the enormous number of these companies that exist and are being formed every day, VCs have to develop a robust formula for determining which ones they will support.
One crucial variable is timing. The earlier a VC can identify value and make investments, the better; companies with strong value propositions will become more and more expensive over time, so the potential upside is huge for VCs that invest early. Another variable is the size of a VC’s portfolio. While most VCs opt to invest in a modest number of companies, there are several drawbacks to this approach. First, a smaller portfolio means larger investments in each company and greater risk. Second, VCs with smaller portfolios have to invest greater resources in due diligence, which often leads to more hands-on portfolio management and even higher costs in the long run. And third, it’s more difficult to develop a diversified portfolio (which can substantially mitigate risk) with a small number of companies.
When companies are afraid to deviate from traditional investment strategies, their chances of capturing alpha are slim — especially when it comes to 4IR investments. VCs interested in 4IR should look beyond the usual suspects in Silicon Valley and consider a broader range of companies: founders who don’t fit the traditional mold, geographies that have been overlooked and industries that are ripe for disruption.
Status-Quo Investors Can’t Keep Pace With 4IR
The performance of VC investments over time isn’t nearly as high as many people assume. According to data from Correlation Ventures, less than half of the capital invested between 2009 and 2018 broke even, while less than 20% achieved three-fold returns or higher. This is one of the reasons I founded my company — I knew there had to be a more reliable way for VCs to generate solid and reliable returns on their investments.
One of the most important elements of any strong VC portfolio is diversification. For example, a study in the Journal of Business Venturing notes the “documented positive relationship between fund diversification … and performance in venture capital.” The researchers go on to explain that more diversification reduces a portfolio’s risk, which allows fund managers to “select riskier investments in the first place and, thus, investments with higher expected returns.” One element of diversification the researchers tracked was the proportion of investments in early-stage companies — a strategy that yielded higher returns for VCs, despite the risks associated with it.
In other words, VCs should take strategic risks as long as they have mechanisms for mitigating those risks, such as diversification and (in our case) high-volume investing. As the number of 4IR companies continues to explode, VCs should be more proactive about finding them. The investors that build large and diverse portfolios of innovative early-stage companies are the ones that will power the Fourth Industrial Revolution.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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