According to the Harvard Business Review, for each deal that a venture capital company closes, it evaluates an average of 101 options, which results in a closing percentage of less than 1%. To be successful, venture capital firms must have a well-organized and effective deal flow process that helps them source hundreds and thousands of deals each year.
Since venture capital firms invest in so few businesses relative to their overall volume of deals, improving sourcing and managing effective evaluation and diligence processes are key differentiators of thriving firms. Below, we provide four tips to help venture capitalists optimize their deal flow to get high-quality deals.
Centralize All Inbound Leads
Desk clutter is a common reason for inefficient deal flow processes. If your leads are not organized in a way that is easy to access and efficient, you’ll find it more difficult to get the information needed for due diligence and screening. Desk clutter can also hinder communication between your company and its portfolio companies and make it difficult to respond to entrepreneurs and move their startups through the deal flow pipeline.
Investing in deal flow software is a great way to move toward a more organized and cleaner deal flow. Leads from multiple sources are expected in any competent deal flow. These leads must be carefully extracted from various sources and placed on a platform that is used by all of your employees.
The leads can be categorized according to custom criteria such as source, urgency of follow-up, and proposed funding. You should also centralize all emails and messages into one directory with cross-references. You won’t have to go through lengthy email threads each time you want to follow up on one of your startups.
Deal flow tools can automate many tasks associated with deal sourcing, evaluation, and execution, which saves you precious time, reduces errors, and allows your team to focus on higher-value activities.
Conduct Due Diligence
Your due diligence might come later in the funnel than sourcing new leads, but it’s better to reject a deal after due diligence than to allow a flop to sign a contract. Due diligence on newly-opened businesses can be a challenge, as they have less tangible evidence that proves their value.
Follow these simple due diligence guidelines to make sure you’re investing in businesses that are positioned for success.
- Analyze the team holistically, from individual contributors to the product.
- Talk to existing and potential clients to gauge the traction of your offering.
- You can hire experts to evaluate the product offering.
- Research past employees and evaluate the trustworthiness and reliability of the team and co-founders.
Keep an eye out for portfolio company founders who are doing reverse due diligence on you. Remember that founders are always encouraged to do due diligence on all capital partners.
Venture capital investments are risky by nature. As leads arrive, you can adjust your firm’s level of risk and set expectations. This will help you establish what a good deal is. When managing investments, it’s important to balance a quick return and high potential.
Every decision that a venture company makes should be based on the desire to take risks.
You should base your decision on whether to increase or decrease risk exposure by following these steps to risk management for each investment opportunity.
- Risk identification: Identify the top 30 risks that each portfolio company faces.
- Quantification of risk: Calculate the enterprise-wide risk of the VC Portfolio.
- Risk decision: Make informed choices about how to respond to significant risks.
- Risk Communication: Inform limited partners of VC funds.
Set the Right KPIs
Setting clear KPIs is a great way to quantify the quality of deal flow. There are three primary metrics to measure quality deal flow.
Deal Volume and Quality
The quantity and quality of your deals must be measured. The VCs are interested in how many startups come knocking on their door and whether they fit the fund’s criteria, such as industry, team, stage, funding requirements, etc. This goes on to show which deals are the most successful and fit with your investment philosophy.
The source of your team’s deals is another aspect of success. You can track deal sources to see which ones are most likely to generate new opportunities. Or, you can find out which geographical locations have the best prospects or which team members are most connected in your industry.
Giving support to the industries and communities you invest in can provide new opportunities for engagement and the future. It’s important to establish a strong brand presence in the industries that you serve. This will help expand your network and open up new opportunities for the future. Different investors may choose to measure KPIs differently, but the important thing is to adopt a comprehensive set of metrics over time and to be consistent in your measurement.
Improving your deal flow for high-quality deals can be a daunting prospect. However, by centralizing all inbound communications, managing risk, doing your due diligence, and setting your KPIs, you can optimize your deal flow to fit all your business needs.