Why So Many VC Firms Invest in the Same Companies

I was asked recently why venture capital firms all appear to invest in the same "stuff." Take a scan of the VC sphere, and you'll see the reason for the query. A number of firms seem to be playing in the same sandbox--software, life sciences, healthcare, digital media, etc. Why does this happen? The answers are simple, and they also underscore the inherent roadblocks to funding that many startups face.

Opportunity, scalability, margins
A common thread across most venture-backed industries is the ability to get big rapidly--and I mean really, really big. Everyone's looking to cash in on the next Facebook or Google, where an investment of several million dollars turns into $1 billion within 10 years. But growing big requires a product that can scale quickly, delivers good margins and is out to capture a sizable market--such as the entire planet, in the case of Google, or the trillions of dollars spent annually on healthcare.

The problem is that there aren't a lot of industries that are primed for this kind of frenzied growth. Software stays on the VC radar because it's easy to distribute; healthcare products are mainstays because they command premium prices. Mature industries such as automobiles? Not so much.

If you've got a product that has a considerable audience, is scalable and has potential for big profits, put together a presentation and try to pitch your
business model to a VC firm, as you'll likely need their money to compete in a hot market. If you don't have those three qualities, you can either pivot or go after more traditional funding (and slower growth).

Solid Relationships
Dig under the surface of a venture capitalist, and you'll likely find a onetime entrepreneur who has worked with a trusted roster of managers, investors and other entrepreneurs for years. When it comes to doling out millions, it should be no surprise that he or she is going to go with who and what they know. It's easier to invest someone else's money in an entrepreneur with a proven track record or a talented former colleague than in someone you don't know.

Yes, it's incestuous. Yes, it's tough to break into. But that's how it works. And it's another reason to expand and maintain your network as best you can. Among the VC set, relationships can be as important as ideas.

The tech industry is a model of networking, with events almost every week in nearly every city. Find out where your industry meets and start introducing yourself. Accelerator programs are also effective ways to get yourself and your idea in front of investors.

If all this is making you feel left out of the party, don't take it too hard. Today's hot sectors may well be tomorrow's snores. In the 1980s, PC startups were everywhere. Now it's mobile software.

And in some form of karmic justice, it's VC firms that are often left out of the rapid discovery of huge new markets. Due to their structure of relatively static funds, many are stuck with an investment for 10 years--long enough to have jumped on, say, the daily-deals bandwagon of 2008, only to be left out of this year's newer, hotter emerging industries.