Venture capital deal flow is the sum of several moving parts, all of which work in tandem to create one smooth deal pipeline. Deal sourcing, deal screening, due diligence, and negotiations form a sequence of processes to be executed before a VC deal is finalized. Since these processes are often interdependent, inefficiencies or bottlenecks in any of them can render the entire deal flow ineffective.
For instance, the use of improper deal-sourcing methods can cause a high influx of low-quality leads, which puts the deal screening and due diligence processes under pressure. Similarly, inefficient follow-ups can cause leads to go stale, which reduces the number of leads entering the pipeline in the first place.
Modern deal flow processes are often expansive and incorporate several different deal-sourcing channels to help generate high quality leads. Post deal sourcing, deal screening and due diligence, bolstered by open communication, work in parallel to achieve efficiency in deal flow. However, the inclusion of more sub-processes makes the deal flow process more susceptible to operational failure. It’s crucial for VCs to ensure the efficient functioning of every sub-process and internal communication channel to avoid bottlenecks that can obstruct the entire deal flow.
Identifying the pitfalls in your deal flow
While no deal flow is perfect, you can avoid major issues if minor inefficiencies are identified and fixed in time. By establishing responsive deal processes that are both scalable and easy to monitor, VCs can incorporate a regular feedback cycle that makes problems easier to manage.
For instance, a responsive deal screening process allows screening teams to comment on the volume and quality of the deals they receive and suggest operational changes that support better evaluation of startups. Responsive deal processes leverage first-hand feedback from investment teams to identify deal flow pitfalls and provide viable solutions.
Another way to identify deal flow problems in time is regular operational data analysis. Routinely collecting and analyzing deal process-related data allows VCs to closely track their deal flows and ensure their performance is up to expected standards. It also helps them uncover any inefficiencies underpinning the failure or underperformance of the deal flow process. While generating performance reports allows you to leverage operational data to solve problems currently plaguing your deal flow, creating a data repository helps you monitor the future performance of your deal flow management process.
The five biggest pitfalls of deal flow (and tips to avoid them)
Here are the most common deal flow pitfalls that VCs encounter.
Being isolated from other investors
Startups have the luxury of choosing from an abundance of fundraising options, including crowdfunding, angel investors, venture capital, and accelerators that run comprehensive entrepreneurial education and leadership programs to help budding entrepreneurs hone their skills, which in turn feeds deal flow pipelines with quality leads.
The plethora of investment options available poses a challenge for VCs who struggle to stand out from the competition and prove their value to entrepreneurs. In a scramble for the survival of the fittest, VC firms that fail to adapt to the changing investment landscape risk being isolated within investor networks and lose out on quality deals. While it’s natural to bank on tried and tested deal-sourcing methods, it’s also important to expand your outlook, find new ways to connect with investors and entrepreneurs, and build on your social capital.
Start by using digital channels like social media platforms, blogs, and discussion groups to connect with investors, exchange ideas, and share deal-related information. This will help you reinforce your referral networks while forging valuable business relationships centered on trust and goodwill. It’s also important to regularly conduct market research to uncover key trends and leverage them to strengthen your investment portfolio. In-depth analysis of global capital markets and macroeconomic trends will help you make better investments and stay ahead of the competition by actively focusing on mitigation strategies for future risks.
Ineffective follow-up cadence
In highly competitive modern capital markets, VCs need to actively show intent and interest in their startups. There is always tremendous competition among investors when it comes to investing in entrepreneurs with impressive startups. You always risk losing your best leads to other investors, which narrows your margin for error.
By maintaining timely communication with entrepreneurs and an effective follow-up cadence, VCs can instil trust in the startups they interact with and in their portfolio companies. Active follow-ups inspire confidence in startups that the VC has genuine investment interest and can help them acquire the capital and industry connections they need.
The first step towards establishing an effective follow-up cadence is centralizing and organizing all inbound communication. Interesting startups can often get ignored amid the clutter. Categorizing all inbound leads will help you sift through the chaff and prioritize follow ups for effective communication. Dedicated deal management software also allows you to message, auto reply to emails, and extrapolate important talking points all on one platform, making it easier for you to organize your inbound and outbound communication and give adequate attention to every startup.
Not paying enough attention to risk mitigation
Investment risk mitigation isn’t a one-off project or periodic focus area but an active and continual process. Global financial markets are subject to ever-changing risks that need to be monitored closely in order to avoid losses and make sound investments. VCs that do not develop dynamic risk mitigation strategies suffer the consequences of making bad investments that ultimately affect their portfolio performance. It’s important for you to establish continuous market risk assessment processes that take into account macroeconomic trends to inform your investment decisions.
Another aspect of active risk mitigation is foreseeing the legal problems that accompany investments in certain sectors. It’s important for you to ensure that all your portfolio companies follow regulations like GDPR to avoid disciplinary action (including fines) and loss of reputation.
Scattered deal sourcing processes
While it’s important to have multiple sources that offer access to a diverse range of deals, you run the risk of losing focus with a deal funnel that’s too wide at the sourcing end. No matter how many deal sourcing processes you employ, focus on finding the right deals that fit your investment thesis. This requires you to constantly monitor and tweak your sourcing process to reflect your immediate portfolio needs.
For instance, if your investment risk analysis suggests investing in real estate to offset potential losses, you should actively leverage your real estate industry connections and look for quality startups in the real estate industry for your portfolio. Similarly, when breaking into a new sector, look for several small, promising startups that can help you build a strong portfolio from scratch. Keeping your deal sourcing processes aligned with your business goals is the first step toward building a more effective deal pipeline.
Inefficient deal processes
It’s important to keep all your deal processes (from sourcing to partner review) efficient and updated according to current industry standards. This includes switching to deal flow management platforms that save your time and resources on menial clerical tasks like capturing and organizing all relevant lead data within a central database.
Zapflow is an intelligent deal flow management platform that automates deal processes and generates detailed performance reports. It also enables the categorization and storing of all lead data according to custom parameters like lead status and market sector. Other features like on-demand portfolio analysis and extensive web-based competitive research can further help streamline deal flow for VC firms. Contact us for a free demo today.