Every good venture capital fund has a thesis. They can tell you what they plan to do with the money they raise. At Sprout, when we vet funds, we look for real clarity in two areas in particular:

• Thesis: A clear articulation of the sector(s), stage(s) and geographical focus of the fund. What companies will the fund be investing in, where, and how many companies will make up the portfolio?
• Target identification: How does the fund find the best companies, identify them, and win these deals – particularly important as the best deals are often highly competitive, and finding a great company doesn’t necessarily mean you will have the opportunity to invest in it.

In this blog, we are going to dive deeper into a fund’s thesis, and how different theses may influence investors’ fund preferences.

Sector

Generalists vs Specialists

• Some funds specialise in one, or a handful, of industries. They will typically do this because they have a view on these sectors being particularly high-growth, or under-invested (better valuations / less competition for investment). The investment team may also have a particular heritage in that sector, having worked, founded or invested in businesses in this sector previously which gives them an edge.
• Other funds may be more generalist, and invest across many sectors, instead focusing on other themes that group their target companies (see below on stage or geography).
• Specialist funds can be a great way of backing a particular sector or emerging technology that you’re interested in, or believe to be especially high potential (e.g. fintech, climate tech, SaaS), or highly specialised areas (e.g. blockchain, biotech). These specialist funds will often see more of their target market, and may be better positioned to understand businesses and their competitive advantage. However, specialised funds will have clear parameters and will not give you exposure to other industries or areas.
• Conversely, generalist funds will see and invest across a much wider range of companies. They are more agile and able to follow trends, and less likely to be forced to pass on an exciting company that’s outside their remit. Naturally, they will often lack true depth of expertise across all sectors (unless they can assemble a large enough team), and may still skew towards certain industries where they have a better network, or prior experience. Generalist funds are also often less likely to enter the most technical industries, unless they lean on the expertise of others.
• Many investors will deliberately invest through VC funds to target industries that they like, but don’t understand well enough to invest in themselves.

Size Potential

• Companies in different sectors operate in different markets. These markets are all different in size, and have different exit potential. For example, when selling software to businesses, there is a large pool of potential clients, and software businesses can scale more quickly than product-focused businesses. More niche products naturally have smaller addressable markets, and funds will need to take into account companies’ ability to roll out additional products and services
• This scalability is one reason why typically consumer brands don’t reach unicorn status as often as software or tech businesses. It’s significantly harder to reach that size with a consumer brand, due to a number of factors including pricing, product differentiation, recurring revenue (or lack of), and scalability of costs relative to revenues.
• Many angel investors will invest in consumer or B2C businesses as they are more tangible, and often more exciting. However, these businesses are often much harder to scale and operate in more competitive markets.

Considering Cyclicality

• Certain industries are more cyclical than others. This means that their performance correlates more strongly with the economic cycle. Businesses such as consumer goods are highly cyclical as consumer spending correlates strongly with the macroeconomic climate. Biotech and other more innovative industries are less cyclical as they typically operate with longer innovation lead times across multiple cycles, and are therefore less susceptible to short-term economic fluctuations.
• In general, businesses that require longer-term investment in product, and those that are entering or disrupting large markets, are less vulnerable to economic cycles.

Stage

A common misconception is that venture capital funds only invest in very early stage, speculative investment opportunities; however, in reality venture capital funds pursue a range of different strategies both in terms of thesis, and stage (or maturity) of investment.

Read our previous blog on the pros and cons of investing at different stages.

Geography

Known vs Unknown

• If you’re based in the UK, you will likely not have access to many deals outside your personal network, or at least outside your country. In Europe in particular, different countries & regions can build exciting communities in particular industries – for example the deep tech industry in Scandinavia, or fintech in Lithuania.
• As the global VC market is quite fragmented across borders, VC funds with a particular regional focus can give investors exposure to a wider geographical array of founders and businesses. Some of the biggest success stories are often far too large for individual investors to access by the time that people in other countries have heard of them. Backing local managers can mitigate some of this risk.

Market Size and Expansion Considerations

• It’s easier to build a large business in the USA than it is in the UK. The market is larger, population is higher, and GDP is many times higher. UK-based companies have to expand to other countries at some stage if they want to grow, and then there’s the decision of moving into the USA (same language, far away) or Europe (close but different language). The same goes for any other smaller (non-US) country.
• Some funds specialise in scaling businesses beyond borders. This is a specific value-add skill in itself. This can be a crucial decision point in companies’ growth stories, and investors should factor in the size of opportunity within the country that they’re investing in.

As you can see, there are many considerations for us when we diligence and partner with funds. We strive to bring our community a good mix of funds across sectors, stages, and geographies, whilst always setting the bar as high as possible on quality and track record. All funds are attempting to make the best returns possible for their investors, and they just have different ways of getting there.

Sometimes, it’s easy to look at two funds and decide which is better (something we do when filtering out funds we don’t want to work with). However when faced with a selection of 3-5 top-tier funds, there’s no guarantee which fund will perform the best. Investors will often factor other criteria, such as those above, into their investment decisions, which can often be very personal, preference-based decisions.

At Sprout, we are not here to tell you how to invest your money, and into which funds. However, we curate a selection of top-tier funds, and let you choose which funds you like, taking the above into account.

We will be sharing a detailed guide to how we filter funds in the coming weeks. Stay tuned to learn more about that.

— Capital at risk. T&Cs Apply. Nothing in this article constitutes investment advice. —