Ranking VC’s has long been a mystery – some try to do it with number of deals, others turn to the entrepreneur for reviews. Chris Farmer, a VC at General Catalyst Partners, created a new index to measure VC’s against one another. InvestorRank (inspired by Google’s PageRank)
looks at the connections between VC firms. Whenever two VC firms co-invest in the same deal, that creates a bond between them. If one VC firm follows another one in a later round, that boosts the rank of the earlier investor. (via TechCrunch)
This method measures leadership (those who take the leap first) and reputation (those followed by other investors). What’s interesting with this network analysis is that it’s not concerned with past returns, or even deals with returns at all. Historically, a small number of firms have always generated the bulk of returns (a demonstration of the 80/20 rule). When InvestorRank and the VC landscape are analyzed together, this affirms the decision of VC’s to “follow the leader” and to cluster over the same investments so to maximize their own returns on the same firms.
However, this is problematic because of information cascades, where agents observe the actions of others and ultimately make the same decisions while ignoring private information signals. If this sort of ranking is to be taken at face value, then it can only feed into the whole idea of a tech bubble (of the web startup strain) growing with the increased “reputation” of certain VC’s. It is likely that the portfolio companies of these top InvestorRanked VC will see an overvaluation, especially in the secondary market. With InvestorRank made public, how much can these rankings further influence the investment decisions of other VC’s and private investors?