Everything you need to know about deal flow for VC firms

When it comes to making investments, there is no standard formula for success. All an investor or firm can do is gauge the potential of a deal to the best of their abilities and take a call on whether to invest in it. 

There are, however, a few elements that set a good deal apart from a bad one. Companies that find a monetizable market niche and build a product or service to address customers’ pain points are worth investing in. The most high-potential companies continually create demand, generating a self-sustaining revenue stream. Good deals are, therefore, distinguishable by strong market performance in an industry with great prospects. 

Good VC deals are hard to come by, and even when they do, they are hard to close. As a VC, you need good deal flow. Here’s an apt analogy: if high-quality deals are the perfect cup of coffee, deal flow is like the French Press that beans have to go through to yield that coffee. This means that if you’d like to keep enjoying perfect coffee, you need to find the right beans and keep your machine in good working order. 

To keep your deal flow machine efficient and effective, you first need a good handle on what deal flow is and how it typically works for a VC firm. You can then move on to specifics like what rate of deal flow is ideal and how you can make your deal flow more efficient. But first, let’s get the basics in order. 

What is deal flow?

Deal flow is not only the total number of investment opportunities received by a firm but also the rate of flow of these opportunities. Unlike quantitative investment-related metrics (such as projected revenue, ROI, etc.), deal flow is both a quantitative as well as a qualitative measure that factors in the volume and quality of opportunities received by a VC firm. 

While firms might utilize different processes depending on their industry and preferred deal type (some firms exclusively fund seed-stage startups while others focus on mature companies with proven revenue models or product-market fit), deal flow generally consists of five stages: 

  • Deal Sourcing 
  • Deal Screening 
  • Partner Review 
  • Due Diligence 
  • Capital Deployment 

Deal sourcing 

The first and arguably most important phase in deal flow is deal sourcing. It refers to all the processes a firm employs to find relevant deals and introduce them into its deal flow pipeline. These deals are further analyzed and evaluated using key parameters like annual revenue, projected growth, unit economics, cost of customer acquisition (CAC), burn rate, etc. to determine whether they advance further down the deal flow funnel. 

Deal sourcing is conducted through several different methods like relying on network referrals, creating industry watchlists, and using deal sourcing tools like specialized CRMs. It’s important to move beyond traditional deal sourcing methods and diversify your deal flow pipeline. 

Deal screening 

In this stage, deals are filtered based on key criteria. Company founders and executives are interviewed to learn more about the team and assess how their backgrounds are aligned with the company’s growth objectives. Important information like projected revenue, profits to date, and type of legal structure is collected in this stage. Companies may also be filtered based on qualitative parameters like industry, check size, and funding round to match the firm’s investment thesis.

Deal sourcing tools like CRMs can help VC firms collect this information remotely without having to make time for in-person meetings. VCs can send companies webforms to fill in all the required information. Most advanced CRMs are capable of capturing and uploading this information onto the firm’s database automatically. 

Investment team review 

In this stage, the investment team, including the analysts, starts analyzing the deals. The younger team members usually take the first pass through the deals and filter out the potential opportunities. For the most interesting deals, the investment team might hold one or two rounds of phone calls with the founders to understand more about the business.

Then the most interesting deals are sent to key decision-makers in the firm, including partners, who evaluate each deal based on the company’s viability and potential for growth. The partners evaluate deals and make a decision about which ones are worth investing in.

Due diligence 

VC firms conduct due diligence on all shortlisted companies to uncover in advance any unsavory legal or financial issues that might otherwise emerge after a deal is completed. The idea is to identify any potential deal breakers before making an investment. 

This phase entails comprehensive background checks of key team members, deep dives into operational and accounting processes, and even conversations with clients or users of the company’s products and services. A large number of deals failing the due diligence process is indicative of poor deal flow, which can cost the firm significant time and resources. 

Capital deployment 

Once a deal passes the due diligence process, it’s considered approved for investment. The VC firm then draws up the term sheet and other relevant documents. Once they are signed by all parties, the firm wires the agreed upon amount to the company. 

Finding the right deals 

Every deal flow pipeline is susceptible to quality issues that could reduce its efficiency and yield, which increases friction in the VC firm’s decision-making process. The first step towards streamlining deal flow is ensuring that more high-quality leads enter the pipeline right at the outset. 

It’s high-quality deals that generate maximum returns for VC firms. 80% of VC firm returns come from the top 20% of deals. This underscores the importance of finding great deals that can generate exceptional ROI. 

Let’s look at two tried and tested ways to source quality deals and build your pipeline:

Networking referrals and warm introductions

The world’s top VC firms acknowledge the role networking plays in sourcing quality leads. VCs source as much as 80% of their deal flow through network referrals and are much more likely to invest in referred companies that come with a seal of trust. These companies have already been informally vetted by trusted associates aware of the firm’s investment criteria so these companies are more likely to pass all screening and due diligence checks. 

A VC firm’s screening process covers everything from financial and legal due diligence to reputation and background checks. For startups that enter the pipeline through cold emails, this process can take weeks or even months. However, since network referrals come from a trusted associate who makes a warm introduction, they might sometimes be fast-tracked through the due diligence process, which speeds up deal flow. That’s why a healthy volume of network referrals is essential to achieving quality deal flow.  

In warm introductions, the startup company’s founders are personally endorsed by a trusted contact in the VC firm’s network. These introductions could be made by business associates, family or friends of a firm’s partners or employees, or even consultants who connect the firm with quality leads in exchange for a percentage of the deal’s proceedings. Startups find warm introductions to be the best way to connect with VCs because a person whom both they and the VC consider trustworthy is vouching for them. 

The trustworthy associate who makes the referral should be well aware of both the business being introduced as well as the investment criteria of the VC fund. That’s why close business associates and ex-employees are considered valued contacts when it comes to warm introductions. Being familiar with the investment thesis of the VC fund enables them to make good judgments when it comes to sourcing deals. Further, it’s important to note that they can only make successful introductions if they maintain honorable and amicable relationships with both the VC firm and the startup company. 

Attending industry events 

Attending industry events is a great way to expand your existing network and uncover new opportunities. These events provide an excellent, curated platform for industry professionals to come together, exchange ideas and insights, and collaborate. By attending the right events and conferences, VCs can connect with startup founders and source great deals. 

However, it’s important to know which events can help you find deals that fit your portfolio requirements. Let’s understand this better with an example. Say your firm is looking to invest in promising fintech or alternative asset companies. It would take your team far more time and effort to identify viable startups in these sectors at a general business convention or sector-agnostic startup conference. 

On the other hand, a convention organized by the American Securitization Forum is a better venue to come across such companies. This organization partakes in lobbying and decision-making related to both fintech and alternative assets like crypto tokens, making its events a natural channel through which to find the kind of companies your VC firm is interested in. 

Regardless of how they organize their deal flow, VC firms should track their leads meticulously. One way for VCs to segregate deals is according to the source. By closely tracking the performance of invested companies, you can identify what sources yielded the best deals and tweak your deal sourcing strategy accordingly. 

Creating a deal flow pipeline 

For VC firms, deal sourcing, screening, and due diligence are all recurring processes that run in parallel as cogs in the larger deal flow machine that captures leads on one end and churns out successful investments on the other. It’s important to set up these processes to run in tandem to create an efficient and streamlined deal flow pipeline that is aligned with the VC firm’s investment thesis. 

Here are a few tips to help you create an effective deal flow pipeline: 

Use an omnichannel approach for sourcing 

No matter what industry a VC firm focuses on or the investment strategy it devises, it cannot achieve its goals without using multiple channels for deal sourcing. Using several deal sourcing methods, including both network referrals and cold outreaches, can help firms achieve healthy and diverse deal flow. 

Publish your investment thesis and share it with your network

VC firms often decide to focus on certain sectors at the outset. Even within an industry, they sometimes focus on startups that are at a certain stage (for example, seed or post Series A) or those whose products or services fall within a certain subset of the sector. 

Many firms publish an investment thesis - a statement of what types of companies and sectors they want to invest in and why - on their website. As a VC, the best way to invite deals that align with your firm’s investment thesis is to communicate it widely within your trusted network of business associates. Some VC firms share their investment thesis on social media to cast a broad net for leads, while others communicate it to their existing portfolio companies. These companies might be a great source of referrals to other relevant companies in their industries of operation. 

Scout actively 

Scouting involves finding early-stage companies that have potential and nurturing them to an investable stage. It’s a highly underrated stage of the deal flow pipeline, given the time, effort, and resources it requires. However, if done right, scouting can pay off in various ways. 

As a VC, you can ascertain that leads that emerge from the scouting process are high quality, given that they have been mentored by your firm. Moreover, in the face of competition from other VC funds, building relationships with high-potential startups early on can be beneficial because they will be more likely to approach you when they require funds to grow. Scouting allows your firm to create a strong network of emerging companies in your industry of interest and be known as a leader in that sector.  

What is the ideal deal flow?

An ideal deal flow strikes a good balance between the quality and quantity of leads generated. While it’s important to only let quality leads filter through your deal flow funnel, generating too few leads is a risk that can affect your firm’s credibility, reputation, and revenue. Generating just the right quantity of high-quality leads allows your firm to invest enough time and resources into the thorough due diligence required to evaluate each investment opportunity. 

An efficient deal flow pipeline is imperative to achieving the ideal deal flow for a VC firm, and maintaining an open and transparent feedback loop helps sharpen this funnel and increase its efficiency. However, it’s worth noting that this ideal deal flow might vary over time depending on the firm’s immediate business goals that are susceptible to change. In cases where a firm has just been launched or, conversely, is looking to scale by investing in a new sector, the quantity of deals might take precedence over quality in the deal flow process. However, if the firm is already heavily invested in a sector, it might only consider a few high-quality deals. 

Using a deal flow management platform 

VC firms today need to track every opportunity closely to generate actionable, data-driven insights and stay ahead of the competition. Some of the world's leading VC firms use comprehensive deal flow management platforms to streamline their deal flow pipelines because this process requires more features than those offered by regular CRM software, especially at a sizable investment firm. 

Zapflow is a deal flow management platform that takes care of everything from organizing both inbound and outbound communication to generating easy-to-read quarterly reports and portfolio analyses. Our Explorer module helps firms find all competitors, acquisition targets, and exit opportunities for any given deal within seconds. 

An intuitive productivity-enhancing tool, Zapflow enables VC firms to harness the power of AI and business intelligence. With Zapflow, VC firms can streamline all their business processes and achieve unparalleled efficiency. 

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