Why are VCs funding technology for the future - using KYC processes from the past?
Venture Capital (VC) firms, family offices and private equity funds operate at the forefront of digital disruption, always racing to fund the ‘Next Big Thing’ in technological advancement. There is heavy investment in companies that digitize business processes – in 2023, technological companies received approximately $315 billion globally. However, when it comes to their Customer Due Diligence (CDD) and Know Your Customer (KYC) processes, many investment companies still rely on old-school systems, often involving spreadsheets and manual procedures.
Why is KYC a blind spot for investment firms?
While some areas of the industry have been digitized by now (such as relationship management, data rooms and deal tracking), it’s typical to encounter a firm still running certain processes, such as their KYC and CDD tasks, manually. Requesting sensitive information from investors often follows these steps:
- Fund sends an email to the investor asking for information (such as financial details or a passport copy) and manual completion of a PDF questionnaire.
- The firm waits for a reply and sends reminders if necessary.
- The investor replies with their completed and signed questionnaire, along with the required documents.
- Responses are saved in an Excel file and documents are stored in a shared folder, e.g. Google Drive that’s accessible company-wide.
The process above is repeated for every investor and whenever CDD checks are needed. It’s a messy, error-prone and time-consuming way of working for all parties – not to mention highly insecure. So why don’t investment firms leverage the KYC tools at their disposal?
Reluctance to change
VCs and funds are busy. They’re networking, chasing unicorns, managing their portfolios. Often, the impact of a 50+ hour working week means that they don’t have time to pick holes in processes that they believe are working just fine. If only they knew that workflow improvements could save them hours each week, perhaps they would prioritize automating elements of their KYC burden.
There’s also a mindset shift that needs to happen, relating to the nature of the industry. In the past, early start-up investment was about making decisions and deals instinctively, often face-to-face. Many VCs started small and scrappy, with an over-reliance on gut instinct and spreadsheets. Even after these firms grew, embracing the full benefits afforded by technology was not necessarily instinctive. In 2023, VCs invested in Generative AI to the tune of $22 billion, yet many are still failing to leverage automation in their own KYC processes.
Lack of risk awareness
Funds, VCs and family offices aren’t deliberately putting their investors’ sensitive information at risk. More often than not, they haven’t fully considered the security implications involved in sending personal data over email and storing information in insecure files - in addition to matters such as the General Data Protection Regulation - known more commonly by its acronym GDPR - if either they or any investors are located in an EU country. Furthermore, they may be unaware of the implications of failing to mitigate money laundering and terrorist financing risks.
Changing regulatory landscape
Like many businesses, investment firms find it challenging to cater to regulations that are location-specific and regularly evolving. Even if they hire someone to manage compliance, it can be overwhelming to stay on top of all the global news, developments and trends in sanctions and regulatory compliance. This can be even further compounded if the VC or fund invests in any industries that are considered to be “higher risk”.
Talent shortage
Experts are increasingly hard to find, especially in the world of compliance and KYC. Firms may feel nervous to take the plunge into changing processes without the support of a dedicated KYC team on hand. And there isn’t always enough work to justify employing someone full-time, so no one in the business is 100% dedicated to optimizing KYC policies and processes.
Benefits of introducing a KYC tool for funds and VCs
By bringing a KYC platform and partner on board, VCs, family offices and funds can:
Establish more efficient and streamlined processes
Take the above example of emailing an investor for their details. Now imagine that all this information is already uploaded in a digital library, secure and ready to be used at any time. There’s no back and forth with investors and much less margin for human error. A KYC tool saves all parties time and ensures the correct details are always available - especially if it has features such as reminders of when documents and files expire, and so forth. When onboarding a new investor, KYC and Anti-Money Laundering (AML) checks can also be completed more easily and quickly, accelerating the time it takes to close deals.
Some KYC platforms (such as Avallone’s) can even create a diagram of a firm’s full fund structure at the touch of a button, saving funds hours designing charts in programs that aren’t fit for purpose.
Save costs
By automating or delegating certain elements of KYC and CDD, organizations can release their team’s time and energy to spend on more profitable tasks. There is software that can provide faster data matching with answers to KYC questions, and if needed, there are also services which can take on the burden of many of the day-to-day tasks - the costs of which can be much less than hiring specialized full-time employees (FTEs). Additionally, the financial risks of non-compliance are increasing – in 2022 fines for AML offenses rose by 50%.
Enhanced security and compliance
Introducing a KYC tool to your tech stack acts as a protective barrier, enabling investment firms to identify and mitigate risks linked to criminal activities within their portfolios. Trust is paramount in the investment industry and implementing a KYC platform also shows a commitment to compliance and financial integrity for investors and stakeholders. Conversely, a high-profile data breach or failure to screen for sanctions will negatively impact a firm’s finances and reputation.
There’s also the old adage - you don’t know what you don’t know. Without a dedicated partner on hand, a fund may be missing a crucial part of the KYC or compliance puzzle. At Avallone, we’re more than just a platform to facilitate KYC management, we also support our customers with a team of experts to help them set up robust processes with ongoing CDD in mind. We provide expertise as and when needed, saving investment firms time, money and resources they would otherwise need to spend hiring and onboarding dedicated KYC specialists.
Funds can gain a competitive edge through KYC
By implementing more streamlined KYC practices, investment firms can mitigate risk, ensure legal compliance, secure their reputation and improve operational processes for all parties. In the current crowded VC and investment landscape, it has never been more important to improve the experience for investors and ensure your house is in order. Taking care of KYC is one of the lesser-recognized ways to differentiate your firm from others – it’s even more essential for investment firms with plans to scale. The time to act is now.
