I was in one of those VC-to-VC conversations the other day, and heard the phrase, “my deal flow is awesome right now.” To which, of course, I immediately replied, “my deal flow is awesome right now, too.”
But it got me thinking: what is great deal flow? VCs live or die by their access to investment opportunity, so what does it mean to have good deal flow?
On reflection, I think there are four measures of quality deal flow:
Intrinsic quality. This is the most basic measure of all. To what extent are you seeing companies you want to invest in? Companies with strong teams, huge markets, great products, market validation, growth strategies, etc. Every other blog post on VC is about this topic, so I won’t go into any more detail on “what makes a good deal.” I will say that one rough way to measure this is the “conversion” rate from qualified leads, to first meetings, to second meetings, and all the way through the funnel. The high the quality of startups, the harder it is to say no. (Just to confuse things, I’ll add another statement: the higher the quality of the VC, the easier it is to say no.)
Inbound deal flow. The more inbound a VC is seeing, the better “deal flow” he or she has. Outbound is important as well – and VCs can often source their best deals by chasing down particular companies or specific investment theses. But outbound is, ultimately, a measure of how hard the VC is working. Inbound, by contrast, is a measure of how much entrepreneurs value a VC as an investor. The complication, of course, is that inbound leads on new investments can often be of low intrinsic quality. So the real measure is the combination of the two: What proportion of the quality leads are inbound? And what proportion of the inbound leads are quality? High quality inbound deal flow is the best measure of a VC’s “brand” – and one of the ways that brand matters in the venture world.
Proprietary deal flow. In some ways, proprietary deal flow is the Holy Grail of venture capital. And, like the Holy Grail, it rarely if ever exists. A “proprietary deal” is a deal that you as a VC have unique or exclusive access to.
- This is rarely if ever binary. VC investment opportunities are rarely 100% proprietary or 100% public. They are often in a grey zone, and some are more proprietary that others. Most smart entrepreneurs will speak with a few VCs, not just one – whether because they want to hedge their risk, ensure a fair price, or build a syndicate. But from the VCs perspective, it is better to be on the short list who had access than on the long list that read about the investment on Crunchbase. VCs that have access to an accelerator’s class before it hits the press have more proprietary access. VCs that attend demo day, less so.
- Proprietary can be either inbound or outbound. Sometimes, VCs can hunt down a company, create a relationship, and generate an investment opportunity that doesn’t exist for other VCs. Sometimes, an entrepreneur seeks out a specific VC that he has worked with or heard about to talk about a business idea, consider investment, or just explore financing options. That sort of inbound vote of confidence means a lot – and can result in truly proprietary deal flow.
Validated deal flow. While VCs should be comfortable making their own investment decisions, there is no doubt that outside validation of the quality of a company is a great help – and a great measure of the quality of deal flow. Validation can come in many forms – too many to list – but the key ones would include:
- Co-investors, advisors, or key-employees who have joined the company
- Key customers or partners
- The referrer – if someone referred the startup to a VC, that person has tied their reputation to that of the startup, and that’s a very important indicator in some cases.
So when I try to judge myself or the quality of my “deal flow,” I end up asking myself a series of questions. To be sure, my own judgment of the “intrinsic quality” of the companies I am meeting is one measure. But I also think about the other factors: lead source, inbound or outbound, the nature of the referral if inbound, the extent to which it is proprietary, and any objective signals of validation. Only when I score highly enough on all of these measure will I really be able to say my deal flow is consistently “awesome.”
2nd September 7:23 PM