The Role of Data in Venture Capital and Revenue-Based Financing

Venture Capital Investment Evaluation

Data matters at Lighter Capital. It’s the primary tool we use to make financing decisions. Data matters to venture capitalists (VCs) as well. But is it the primary tool that VCs use to make investment decisions? No, according to survey-based research published by PitchBook.

As a data-oriented person, I was interested in the numbers behind how VCs use data today (I would have been more interested had the research been based on actual data rather than a survey). Reading the study inspired me to think about some of the similarities and differences between how we use data at Lighter Capital and how VCs use it.

How venture capital investors use data to evaluate investments

how VC investors use data

A few numbers from the VC survey jumped out at me. Just 37% of venture capital investors said that data is extremely important in evaluating investments (47% said it was somewhat important). Across all types of VCs, less than 25% said that data alone is most important. In contrast, both intuition and data are important to more than 68% of VCs. Not surprisingly, 59% of VCs cite their personal networks as their most valuable deal sourcing resource.

Those numbers surprised me a little. Within the startup ecosystem, opportunities that go heavy on data are hot at the moment. Many within the ecosystem are excited about companies that tackle problems using data science, machine learning, and AI. I would have thought the survey results would show a higher percentage of venture capital investors using data as a primary decision-making tool when evaluating investments.

For most VCs, intuition is just as important as data in evaluating investments, but who you know matters more.

How Lighter Capital uses data to evaluate startups we finance

How Lighter Capital uses data to evaluate startups we finance

My perspective is informed by the use of data at Lighter Capital, where data science guides everything we do. Our primary business is providing revenue-based financing to startups. Lighter also offers term loans and lines of credit. Revenue-based financing provides startups with a resource that helps them advance faster and smarter as they grow the markets for their products. Companies agree to repay revenue-based financing based on a percentage of their monthly revenue. Payment amounts fluctuate in relation to the amount of net revenue, going up for strong-revenue months and down for low-revenue months, giving startups flexibility in their payments.

Entrepreneurs turn to us after they have viable products and measurable revenue even if they aren’t profitable. Often, they have bootstrapped their pre-commercialization phases or worked with angel investors. Many go on to seek VC funding after using one of our products to help grow their business. Others choose strategies of earlier profitability and never turn to equity funding.

Our process for vetting companies calls for their data because our evaluation models use more than 6,000 data points. We evaluate more companies than we finance, so we deal with massive amounts of data on a regular basis. As we’ve seen more data over time, we’ve refined our risk models to produce higher levels of predictive accuracy. On average, we can predict a startup’s revenue growth with 97% accuracy.

Our business decisions are based almost exclusively on data — not intuition or our opinion about factors outside the company’s control. For instance, let’s say a company with a path to profitability faces a difficult competitive landscape. Competitive headwinds might — quite sensibly — cause a VC to pass on the company. But if the financials demonstrate that the company is able to successfully outpace those headwinds by growing revenue, we’ll likely work with them.

VCs look further ahead

VC valuation method

I don’t want to imply that VCs should use data in the way that we do. Lighter Capital and venture capital both support startups, but our business models are quite different. Our data-driven approach narrows our focus, giving us an opportunity to keep refining our models to improve our decision making capabilities. We provide debt capital to companies with persistent revenue streams. The amount of support we provide never exceeds $3 million. Plus, we don’t take equity; we just expect the company to meet agreed upon payment terms.

A VC wants an investment to support a narrative that leads to a substantial return at exit. It’s a more exciting story, and one with a longer arc than what we see. The numbers a company generates after six months or a year after commercialization don’t paint the five- to ten-year picture a VC would want. Venture capital investors must rely on experience and intuition more than Lighter does to fill in the gaps.

The story in the numbers

reliance on data to evaluate investments

Lighter’s heavy reliance on data does not remove the human element. Our experience especially comes into play when we see unexpected results. A company might seem like a great fit at first, but our analysis can tell a different story. When that happens, we look more deeply into the numbers.

Does the company have a hybrid business that combines SaaS and hardware or services? If that’s the case, we’ll look at our risk model. Changing how we’re weighing certain factors might make sense. Does the company have a high burn rate? If so, then it makes sense to see if the entrepreneur is open to doing business in a way that places more emphasis on capital efficiency.

More data ahead

data in evaluating investments

As venture capital investors increase their use of data in evaluating investments, many are likely to use data more proactively to actually source investments. That’s a wonderful development that could further a common VC goal: uncovering great investments that others overlook.

At Lighter, we believe that our reliance on data helps us avoid overlooking promising companies. But we’re not patting ourselves on the back. Our quest to improve the way we use data is continuous, as it likely is for the increasing number of VCs who love data as much as we do.

Interested in learning more about revenue-based financing and how Lighter Capital uses data? Read The Rise of Revenue-Based Financing.


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Lighter Capital Venture Capital Relationships

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