By: Megann Freston
Director of Product Marketing
April 19, 2024
For the last 15 years, if not longer, innovation in private market investment has been led by the US tech sector, broadly, and Silicon Valley, specifically. While that much is agreed upon, an under-appreciated element in the tech boom is how important venture capital (VC) scouts have been to the companies (and fortunes) that VC has produced.
In a retrospective look at VC scouting’s origins, TechCrunch illustrated how Sequoia Capital debuted the approach on a whim around 2009. What started as VC fund leaders informally encouraging founders to back their peers and other startups they were excited about has grown into one of the main engines in the startup ecosystem in the US and increasingly across the EU.
Below, we’ll break down what exactly VC scouts are and the impacts they have on startups, along with some of the challenges—and how startups and scouts alike can overcome them.
What is a venture capital scout?
A VC scout is an investment professional who works for or with a VC firm to identify startups to invest in. Typically, VC scouts are particularly on the lookout for startups that fly under the radar.
Effective VC scouts leverage their expertise of the industries they scout, applicable regulations, and the overall startup ecosystem to evaluate companies in ways other investors either can’t or don’t. They make pitches to VC funds, arguing on behalf of the startup to secure funding for it.
And, ultimately, VC scouts are investors themselves.
Per one insider’s explanation of VC scouting, the best scouts are investment professionals who are “already angel investing and want to….get involved.” Their interest in a scouting venture is tied to an incentive structure in which they benefit if the startup succeeds and provides optimal returns for the fund. If a VC scout does their job well, it’s good for all stakeholders involved.
Understanding VC scouts’ positioning
VC scouts may be employed in part- or full-time capacities by VC firms. In these roles, VC scouts are often paid a salary and compensated on commission through carried interest or other fees.
However, many VC scouts are external, third parties that work with rather than for a firm. In these cases, firms negotiate finder’s fee-like deals with scouts such that the scouts still have skin in the game (not to mention their reputation). This allows for leaner operations, while the same win-win-win principle applies to all scouted investments. If they work out, everyone’s happy.
In a profile of one successful solo investor, the Wall Street Journal (WSJ) highlights how scouts make it possible for Salil Deshpande to manage $745M in VC funds without “investors, analysts, or admin people.” He claims to have “no employees at all”—but “about a dozen scouts.”
With respect to startups, both employee and contractor VC scouts connect founders to funds.
Positive impacts of VC scouts on startups
The impact of VC scouts on startups is that, through scouts, startups gain access to funds. The vast majority of startups do not receive VC funding. Per Forbes, less than 1% of startups actually receive investment capital, which means many founders are left to navigate the business world with some combination of their own capital, crowdsourced funds, cash flows, and credit.
So, on a practical level, the two biggest impacts VC scouts have on startups are:
- Opportunity in the short term in the form of immediately available funds
- Security in the long term by way of a network and more sources of funding
VC scouts use various different tactics to find and fund startups, but they all do it for the same reason: to bet big on companies they believe in, irrespective of what others think. They’re believers and advocates that get funding to founders so they can realize their dreams.
Short-term opportunity: Unlocking access to funding
VC scouts help VC funds find their way to founders. Or, put differently, they help startups find VC funding. VC scouts leverage relationships and expertise to provide opportunities that might not otherwise present themselves. If founders are trying to break through in an overcrowded space, or if their niche is too niche, VC scouts might be the only (or best) way to secure VC funding.
Another way this benefit plays out is in promoting diversity, equity, and inclusion (DEI), as VC scouts can intentionally seek out founders from historically under-represented backgrounds.
For example, the venture accelerator Nex Cubed made news recently by partnering with a nonprofit dedicated to creating investment pathways for students at Historically Black Colleges and Universities (HBCUs). Nex Cube and HBCUvc launched a scout program to seek out and fund Black founders, who at present receive as little as 1% of all VC funding. The joint venture aims to make the distribution more equitable while also providing quality training for future investors.
Long-term security: Tapping into greater future funding
Another major benefit of VC scouting comes from the connections that it makes possible to the VC fund the scout represents and other firms and investors like it, who will be eager to mirror a wise decision. There are also risks here (see below), but the potential rewards outweigh them.
For example, consider the following timeline of a hypothetical VC scouting opportunity:
- A VC scout takes notice of a fledgling tech startup and strikes up a relationship
- Seeing promise, the VC scout supplies VC funding early in the company’s journey
- The funds received allow the company to scale dramatically almost overnight
- The VC commits more funds as the company quickly approaches profitability
- Other VCs and investors take notice and want to get in on the action
That last part is the kicker. Beyond the immediate cash injection that the VC made possible, the real value in this situation comes from what the startup does with those funds. By seizing the opportunity, they’re able to pave the way to funding and growth for the foreseeable future.
Potential challenges with VC scouting
VC scouting is not always the perfect win-win-win scenario detailed above. There are roadblocks and pitfalls that can arise, hampering the success of the startup, the firm, and the scout as well.
The elephant in the room is that VC scouting is a model based on zigging when others zag.
It’s about picking startups that others aren’t noticing, for whatever reason, and betting on the underdog. There are times when the underlying factors at a startup simply aren’t there—at least yet—and the company isn’t able to deliver the promise that a VC scout envisioned.
Some critics have argued that the use of VC scouts can have negative impacts on founders, as VC scouts tend to have less of a committed interest in a startup’s success (relative to a fully committed VC fund or an angel investor). Scouting-secured funding can also multiply the impact of failure, as investors may take note of a VC fund deciding not to re-commit and follow suit.
VC scouting is a risk-reward business, and that can’t be ignored. However, the potential benefits outweigh the risks for enterprising startups who are ready and able to take advantage of scouts.
What VC scouts need to facilitate startup success
VC scouts need many of the same tools other investment professionals do. They need to process massive amounts of data efficiently, and they need to make its insights visible and usable for the funds and firms they’re scouting for. But they also need to network broadly and form connections with founders and other players in the startup world to find opportunities.
All these needs point to the importance of artificial intelligence (AI) and machine learning (ML).
A common misconception is that AI tools will make humans redundant in decision-making processes. In reality, ML empowers investors—including scouts—to make better decisions, faster, and improve outcomes for their firms and the companies that they’ve invested in.
For example, consider the recent meteoric rise of Flashpoint’s VC scout program. Because it’s integrated AI and automation, it grew to 30 scouts over the course of two years (2021–2023), with a target to breach 100 by the end of FY 2023. AI tools allow all of these scouts to reduce response times and increase transparency, which in turn maximizes value for all parties.
Leveraging data to accelerate startup success
Here at Allvue, we’ve seen how impactful VC scouts can be on individual companies and on the market at large. We’re committed to helping nail their fund operations as they find and fund the most promising startups, realizing founders’ missions and reaping the benefits that come along with innovation.
To that effect, we’ve built comprehensive venture capital software solutions that supercharge performance and the investor experience.
Our VC Essentials solution set aggregates data and automates back-office processes to free up manager bandwidth for decisions. Our investor portal empowers VC firms to provide their investors with unparalleled access to their data with analytical tools and a streamlined dashboard. And our investment management suite helps investors get the most out of their relationships.
These are just a few of our tools purpose-built for the VC space, all of which integrate seamlessly into the tech stacks firms already use. You can request a demo to see how they work firsthand.
Sources:
Businesswire. Flashpoint Automates its Venture Scout Program. https://www.businesswire.com/news/home/20230220005264/en/Flashpoint-Automates-its-Venture-Scout-Program
Forbes. Venture Capital Is Not The Funding Reality Of Most Startups—Here’s What Is. https://www.forbes.com/sites/hollyeve/2020/07/06/venture-capital-is-not-the-funding-reality-of-most-startups-heres-what-is/?sh=7975d4cb65ea
Last Money in. Venture Scouts Explained. https://lastmoneyin.co/p/venture-scouts-explained
Sifted (FT). VCs using scouts means founders get the short end of the stick. https://sifted.eu/articles/vc-scout-programme-problems
TechCrunch. A peek inside Sequoia Capital’s low-flying, wide-reaching scout program. https://techcrunch.com/2019/06/07/a-peek-inside-sequoia-capitals-low-flying-wide-reaching-scout-program/
TechCrunch. Nex Cubed partners with HBCUvc to launch scout program. https://techcrunch.com/2023/10/30/nex-cubed-partners-with-hbcu-vc-to-launch-scout-program/
WSJ Pro. How to Manage $745 Million in Venture Capital Solo. https://www.wsj.com/articles/how-to-manage-745-million-in-venture-capital-solo-16dd8fb0
More About The Author
Megann Freston
Director of Product Marketing
