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Beyond Voodoo VC: Can Data Revolutionize Investing in Startups?

Can better data and algorithms do for venture investing what they did for Wall Street? And now that you’re hearing how that sounds, would we even want them to?

You might have heard of Startup Compass back in April when Techcrunch covered its release of data comparing San Francisco, New York, and London as startup hubs. Originally an academic project, Startup Compass’ first tool, the Startup Genome Compass, is a startup benchmarking dashboard built on data from more than 17,000 businesses. The company announced the tool’s private beta launch today in a blog post that claimed:

Our goal has been to take much of the entrepreneurial wisdom amassed in Silicon Valley and put more structure, science and data behind it, enabling us to better separate myth from fact and share the learnings with the rest of the world…

…just like entrepreneurs, startup ecosystem players like investors, advisors and service providers have relied mostly on gut-level pattern recognition when evaluating and working with startups…

we should not underestimate the power of data to enable new novel applications. Every new industry that data flows into it seems to disrupt. The game of baseball changed when Billy Beane brought in the quants. Wall Street is now run primarily by high frequency trading algorithms designed by quants. Why hasn’t data disrupted the startup world yet?

It’s a long post, littered with intelligent caveats, so if your inclination is to dismiss it, read the whole thing first. The idea is to track key performance indicators across sectors and stages, and then search the data for insights into why startups succeed or fail.

So could data disrupt venture investing? Jeff Bussgang of Flybridge told me it already has, thanks to blogging and social media. Where venture used to be opaque, there now exists “an incredibly transparent process.”

But could efforts to more rigorously apply statistics to startup data transform the art of investing? There he’s skeptical.

“Data is never going to change relationships and the importance of relationships,” he told me.

My inclination is to agree. The case for applying data and even the most basic formal models to areas previously ruled by human intuition is strong and has been demonstrated in predictive domains as diverse as politics and marriage.

But as Bussgang suggested in our conversation, the data that Startup Genome Compass provides will be a useful input, not an algorithm to replace the messy venture process. (As an aside, I wrote two days ago that the venture process clearly involves skill, which is more than can be said for some other areas of finance.)

Where Algorithms Can Help: Crowdfunding

Whether or not Startup Genome Compass will significantly change venture investing, I imagine it could be incredibly useful for the coming crowdfunding wave. Crowdfunding platforms are working to prevent really bad bets, in part to meet requirements of the JOBS Act and in part because they know that perception will matter a lot in these first years.

What if a platform like the Startup Genome Compass could function as a check for non-professional investors? Someone is trying to bet $1000 on a startup that the data indicates has an extremely low chance of making it to its next funding round according to the Compass’s modeling. That investment could be prohibited or even better, just set off an alarm that raises the requirements for completing the investment. Want to invest in a company that the data suggests is about to fail? No problem, but you have to talk to a platform provided investment officer first to ensure you understand what you’re doing.

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Even if Startup Compass’ claims of disruption are overblown, it’s hard not to be excited about more data on startups. HBS Professor Noam Wasserman’s 10 years of survey data on startups, compiled in a must read book, offered a good check against industry truisms around how to found a successful company. I asked Professor Wasserman about Startup Genome Compass’s vision and here’s what he told me:

I am a huge fan of shining the light of data on the rules of thumb, gut-level decisions, and anecdotes that usually drive entrepreneurial decisions. After all, that’s the core goal of my own research and of my book: To identify which rules, gut-level decisions, and anecdotes are misleading or even dangerous. Steve Jobs exhorted founders to “follow your heart, but check it with your head.” We will never be able to remove all of the “heart” – we definitely should not want to do so! – but data can and should be a powerful complement to it.

And if the startup world’s intuitions are really that good, they shouldn’t have anything to fear.

from BostInno http://bostinno.com/2012/05/25/beyond-voodoo-vc-can-data-revolutionize-invest...