Bringing VCs into the 21st century:

with transparency at the top of the agenda, investors need to stay ahead to survive

The venture capital industry is a crucial element in the startup ecosystem, providing funding and support to early-stage companies with high growth potential. However, the industry is currently experiencing its greatest reckoning since the dotcom bubble bursting. We’re witnessing down rounds and slashed valuations in real time, as tech layoffs rage on, funding slows and returns decline. The economic downturn sparked a recalibration for investors worldwide, with grave consequences for overhyped, overfunded, overvalued tech giants and their backers.

VC investors have been scarred by the legacy of the scammer CEO. Just last year, FTX’s Founder and ex-CEO Sam Bankman-Fried joined a growing list of now infamous fraudster founders. Theranos’s Elizabeth Holmes, WeWork’s Adam Neumann and ‘Pharma Bro’ Martin Shkreli have all demonstrated the dangers of buying into a ‘visionary’ as opposed to a viable opportunity. But post-Theranos, post-WeWork, post-FTX, the only way for the venture industry to show it has really learned its lesson, is to demand radical transparency.

These scandals have acted as a catalyst for a long-needed change. For years, the VC industry has not kept up with others; staying stuck in the stone age with models which do not encourage transparency and thorough due diligence which are the cornerstones of fostering innovation, increasing social responsibility and entrepreneurial drive.

Professional investors are facing this increasing scrutiny to stay ahead, with LPs demanding immediate clarity and expecting their investment returns to be presented alongside human social impact. As we enter into this new era of VC investing, transparency will become paramount. But that can only be achieved when information is ultra-accessible and readily available. In doing so, due diligence can evolve from a burdensome chore into an easy and ongoing process.

So, how can VCs navigate the choppy waters ahead?

1. Beware of misleading KPIs: Both ride-hailing/sharing apps and grocery delivery services have fallen victim to this phenomenon. “Fear of missing out” clouded investors’ judgment, who got overly excited by growth metrics and soaring valuations.

Of course, that user growth was often driven by generous discounts, subsidised by venture capital itself. A loyal customer base could not be sustained after these tempting discounts ceased. Consumers were in no way sticky and loyal to a brand, switching to competitors when lower prices were offered. User growth is not the only defining metric to pay attention to when seeking out venture opportunities.

Investors need to look under the bonnet to get a more complete understanding of the financials of the business, paying attention to what really is going to drive long-term, sustainable growth. Early stages of growth are very linked to social, political and economic contexts which can lead to quick – but ultimately unsustainable – customer growth. What really matters, and what VCs should be inspecting, is how these companies acquire news customers. A stable business must have three predictable means of acquiring new customers - for example, through social media, digital advertising and SEO strategies.

2. Interrogate the product: VCs should be requesting – and demanding – product demonstrations. They don’t just need to inspect the business’s finances. They should scrutinise the offering, how it will work, how it will scale, and whether there is in fact a true market demand. In fact, if a VC does not request a detailed product demonstration, it should act as a red flag to portfolio companies - a sign that the investors have nothing to offer but capital, and potentially lack the invaluable expertise and guidance truly inquisitive investors can offer.

3. Always be driven by data: Taking a data-driven approach can reduce bias and the inequality gap in startup funding. According to Andre Retterath, only 10% of VC decision makers in the industry are women, and opportunities for female-owned companies account for only 2.2% of global VC funding. It is clear that gender bias is a pressing issue for the industry, and part of this problem stems from outdated data processes at sourcing and screening stages. Data-driven VCs who take advantage of tools which reduce manual workflows will be able to make more investments which fight this inequality gap, ensuring that funds are used for social good.

4. Walk the walk: Transparency should go both ways. If VCs are demanding it of their portfolio companies, they too should practice transparency. VCs need to be willing and able to clearly communicate how and where their values align with their portfolio companies’. Taking it one step further, they should also offer an insight into how the fund is being operated, how it is performing, and what its longer-term plans are. Transparency can be a reputational advantage for both VCs and start-ups.

The venture capital landscape is changing rapidly, and the outcome is that LPs are (quite rightly) increasingly wary and are questioning more how their funds are being invested. Transparency should at the top of VCs agenda throughout the entire investment journey, from the initial KPIs right through to presenting results to LPs. The traditional model of management – namely, spreadsheets – is outdated and not fit for this purpose, presenting a real danger to professional investors. The industry must be brought into the 21st century; ultimately, a digital revolution will drive innovation, foster entrepreneurship and increase financial growth.