Generalist vs. Specialist VCs: Data from 4,000+ Firms and 10,000+ Investments.
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The venture industry has matured to thousands of firms globally and a multitude of investment strategies. Some firms choose to specialise as a way of being more efficient at finding and winning the best deals, while others choose to be generalists so that they can maximise the number of winning investments they can make.
Both strategies can be successful, but what does the data tell us about the relative performance of a generalist versus a specialist VC? In this post I’ll share a summary of findings from three research papers on the topic and what they mean for VC firms as well as individual investors building a career in the industry.
Some background on this blog post: About four years ago when I was an associate at a generalist investment firm (I now work at a fintech startup and angel invest on the side), I wondered whether it was better to be a specialist or a generalist investor. I wanted to figure out the answer to this question at an individual level and a firm level so that I could shape my investing career more effectively.
After three years of investing across a diversity of areas in venture, I concluded that I was probably a better fit for the generalist approach. This was before I firmed up research on the topic, so it means that my views of the data likely have some bias in favour of generalists.
However, as you’ll see in the remainder of this post, the data so far shows that it’s possible to make either strategy work to your advantage. You just have to be mindful of the costs that come with each approach and find ways to limit their impact. The following table is a handy reminder of the pros and cons of each strategy.
With the above table in mind, here are the key findings across thousands of VC firms, investors, and investments.
1. There is no significant difference in performance between generalist funds and specialist funds after you control for wider market and industry conditions. (PitchBook, 2021)
PitchBook analysed the performance of 451 VC funds in the US with vintages between 1995 and 2015. After controlling for general market and industry performance, they concluded that LPs “should be skeptical of any claims that industry specialisation leads to superior performance.” PitchBook’s analysis found no significant differences in performance between generalist and specialist funds.
On the surface, this data goes against what would logically follow from being specialised. The advantages of a specialist firm being more efficient at reviewing deals in its area of expertise, selecting better opportunities in those spaces, and the higher likelihood of the best founders choosing a VC because that investor understands their market, all point to some form of specialism doing better, right? There’s more to the story.
2. Specialist funds tend to outperform generalist funds but the difference in performance is virtually eliminated if the generalist fund has a team of specialists. Generalist funds with a team of generalists fare the worst in these comparisons. (Gompers et al., 2009)
Economists Paul Gompers, Anna Kovner and Josh Lerner reviewed the performance of 800+ VC firms and 3,500+ individual VCs by looking at the IPO or acquisition success rates of 11,000+ portfolio companies from 1975 to 2003. They found that specialist VC firms outperformed generalist firms and that the difference was statistically significant. However, if a generalist firm was composed of individual VCs who had a variety of industry specialisms, that firm did just as well as specialist firms.
The VC firms with the lowest performance in the data were generalist firms that also had a team of generalist investors. The authors of the paper suggested that this could be the result of generalists failing to identify and win access to promising new opportunities in unfamiliar markets.
It’s worth remembering at this point that although differences in strategic focus appear to play a role in performance in this data set, VC firms with the most investment experience usually outperform those that are inexperienced. Experienced investors have stronger reputations, networks, and are better at identifying and timing great investments in attractive markets. This ultimately translates to better performance across both specialist and generalist firms.
The data from this paper also highlighted that VC firms tend to become more generalist in later years. I think this is because firms that do well usually go on to raise more capital in subsequent funds. To deploy larger amounts of capital meaningfully, a VC fund has to also expand its investable universe. This is achieved by widening the investment remit to cover more industries, as well as investment stages, and geography.
3. Performance has a U-shaped (non-linear) relationship with portfolio diversification. VC firms do best when they are highly generalist (strong portfolio diversification) or highly specialist (strong portfolio concentration). Firms in the middle fare the worst. (Matusik and Fitza, 2012)
The final data to consider comes from the work of corporate strategy researchers Sharon Matusik and Markus Fitza. They looked at 4,500+ VC firms that made investments between 1960 and 2000 and from this, they reviewed some 7,500 data points. This allowed the researchers to explore the links between a VC firm’s portfolio diversification and its IPO success rate. Here’s what they found.
High levels of diversification (in other words being a highly generalist VC firm) generated the highest IPO rates in this dataset while high levels of portfolio concentration (in other words being a highly specialist VC firm) also generated strong returns. Firms with moderate levels of portfolio diversification did worse than those with very high or very low levels of portfolio diversification.
According to the researchers, this U-shaped relationship comes from the fact that there are levels of diversification where the benefits of a particular strategy outweigh the costs and vice versa.
For example, a highly specialist firm is more advantaged by its depth of knowledge than it is disadvantaged by being slightly more rigid in dynamic markets. Meanwhile, a generalist firm with a highly diversified portfolio is more advantaged by its exceptionally broad stock of knowledge and experiences than it is disadvantaged by having shallower knowledge in each area of investment. Firms in the middle fare the worst, since they don’t have knowledge that’s broad or deep enough to offset the costs of being a generalist or a specialist.
There are some more nuances to note in this data. It appears that VC firms that invest at the earliest stages benefit the most from high levels of diversification (see chart below). One possible reason for this is that operating in areas of high uncertainty requires a broader and more diverse stock of knowledge. Such diversity facilitates better problem solving relative to the proverbial person with a hammer who sees every problem as a nail.
Also notice in the chart above that late-stage investors have a flatter curve, which suggests that diversification is less critical for firms with a more mature portfolio. Moreover, late-stage investors with average levels of diversification appear to outperform early-stage investors who are also at the mean level of diversification.
Finally, the authors of this analysis found that the link between performance and levels of diversification was weaker when a firm had a good number of co-investors. Presumably generalist VC firms that co-invest with specialists do better than those that don’t.
What does all this mean for VC firms and individual investors?
Implications for Venture Funds
Overall, it seems to me that the best approach is to be a highly generalist firm (particularly at pre-seed/seed investing) with access to a team of specialists (whether that’s in-house, external, or through specialist co-investors). This gives a VC firm flexibility to invest in the most promising areas and to allocate capital efficiently in those areas with input from specialists. There are many firms that take this approach but one example I particularly like is that of Village Global. Here’s how they articulate their strategy.
I also think that VC firms that employ a thesis or a thematically-driven approach are also essentially generalists but with in-house domain expertise. These firms identify a few “themes” or “theses” that they can specialise in, yet, they can still be highly generalist and broad enough to cover investments in a variety of sectors, verticals, and business models. One prominent firm that takes this approach is Union Square Ventures. Here’s a quote from one of the partners at the firm (Fred Wilson) on why this works for them.
The key takeaway here is that a strong and clear direction of investment strategy is critical and that some kind of focus matters, even for generalists. In contrast, the worst approach is to be unclear about where a firm stands and why. This lack of clarity dilutes efforts, makes deal sourcing reactive and ineffective, and probably won’t resonate with any founder or LP.
Implications for Individual Venture Capitalists
My conclusions here are slightly different. If you’re early in your investing career, you benefit from initially broadening your stocks of investment knowledge by seeing and doing lots of deals across sectors (and perhaps even across investment stages). This will help you figure out what areas have the potential to be a good fit for you. The alternative approach is to specialise early in your career. However, that comes with the risk of never getting exposure to areas of investing that could have been a better match for you.
In later years, if you discover a preference for a specific industry or vertical, you could take that up as an area of focus at your fund. You may also choose to join a generalist fund elsewhere but as a specialist. In fact your chances of being hired are stronger if you bring new specialisms to an investment team compared to if you simply try to join as another generalist. Alternatively, if you enjoy being a generalist, you could join an early-stage fund since that’s where high levels of diversification are most advantageous.
If you enjoyed this article and would like to add to the discussion, feel free to comment directly on this post or on this tweet.
Ps. What do LPs prefer? Here’s a survey finding from a report by Atomico.
