Ask Trevor Kienzle about his favourite movies and in an instant he’s gushing about Moneyball. “It inspired me,” says Kienzle, a bald, skinny fellow who hardly looks like the movie’s real-life hero, sports executive Billy Beane. But Kienzle has a bigger point to make.
The movie lionised Beane for building a winning baseball team on a puny payroll. The key: Powerful data analytics that pinpointed valuable players who were underpriced. Take a close look at venture capital—where Kienzle and partner David Coats work—and the same number-crunching magic can be put to work. At least, that’s what they have been contending for nearly a decade.
By 2007 Coats and Kienzle had quit their jobs at mainstream venture capital firms to see if they could set up Silicon Valley’s first quant venture firm. Their mission: To stockpile 25 years’ worth of data on every venture deal ever done, to comb through this data with proprietary algorithms and to pick investments via pattern-matching software. Naively, they thought they could be up and running by mid-2008. Instead, it took an extra three years to raise all the cash they needed.
Today Coats and Kienzle are having the last laugh. Their firm, Correlation Ventures, runs a $166 million fund that has made about 85 algorithm-driven investments in startups. While it’s too early to know for sure whether Correlation has the winning touch, its early showings are consistent with funds that eventually produce double-digit percentage gains.
Correlation’s most obvious winner is a $1 million mid-2011 investment in Virsto, a storage software firm acquired by VMware in February 2013 for about $200 million. That translates into a 5-to-1 payoff for Correlation, or about 185 percent a year before fees. Extra profits take shape as companies raise new money at higher valuations than Correlation paid for its shares.
A look at Correlation’s portfolio shows that likely winners-in-the-making include Good Eggs, Aldea Pharmaceuticals and AirPR.
Many of Correlation’s picks involve young Silicon Valley firms that also catch the eye of notable venture firms such as Sequoia Capital, Accel Partners, Battery Ventures, InterWest and Canaan Partners. Those overlaps are deliberate. Correlation’s secret algorithms weigh heavily on the track records of the entrepreneurs, investors and other advisors. Correlation believes that reputations aren’t random. Also highly prized is a company’s ability to spend money eﬃciently. A prospect rolling ahead on a tight budget looks appealing. A spendthrift rival, not so much.
Beyond that, valuation matters. Correlation’s algorithms often turn up companies in out-of-the-way locales such as Oneonta, New York, where startups are rarer and bargains may be easier to find. Correlation’s selections include a weight-loss company in Chicago (Retrofit), a Nashville payments processor (edo Interactive) and a biotech company in Malvern, Pennsylvania (Galera Therapeutics).
Correlation typically invests $100,000 to $3 million at a time, making it a small to midsize participant in financing rounds led by a fresh venture capitalist. That means Correlation needn’t repeat the extensive due diligence of other investors that have already confirmed the startup’s health and probity.
As a result Correlation acts fast, typically injecting funds into companies just two weeks after initial contact. Traditional venture firms can take as long as six months.
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(This story appears in the 25 July, 2014 issue of Forbes India. To visit our Archives, click here.)