Almost all venture capital firms strive to serve one broad purpose - bridging the gap between funding sources and promising entrepreneurs who can use this funding to build large-scale startups. However, each VC might have its own motivations and end goals for managing its portfolios.
Investment portfolios are specific to firms and are heavily influenced by their investment thesis, referral networks, and other preferences. This makes the concept of a ‘perfect’ deal flow extremely subjective to each individual VC. Deal flow is an inherently qualitative parameter that takes both the quality and amount of deal opportunities that a firm generates into consideration.
What is an optimized deal flow?
An optimized deal flow is essentially a streamlined deal flow that makes the best possible use of all available resources. Optimization entails tailoring each deal process from deal sourcing to due diligence so that they work in tandem to achieve the desired result - a steady stream of quality deals that helps the VC firm strengthen its portfolio and generate returns for its LPs. Each process is essentially designed/re-designed with a clear set of objectives in mind. Let’s explore this concept further with the help of a hypothetical example.
VC firm X’s investment portfolio hasn’t been performing up to the expected standards. Partners and other key decision-makers at the firm run a comprehensive quality check on the deal flow and identify a bunch of problems. Based on these, they draw up the following list of business objectives that are to be kept in mind while optimizing each deal process.
- Acquire more diverse leads.
- Invest more in fintech startups to mitigate current investment risks.
- Start scaling to build an exclusive Series A investment division.
Based on these objectives,
- All deal-sourcing channels, including the firm’s website, put out calls for entrepreneurs from marginalized/underrepresented communities.
- Venture scouts with a good reach within these communities are hired to spot and nurture entrepreneurial talent.
- Referral networks are leveraged to generate more quality fintech leads.
- Employees and business associates are encouraged to socialize with Series A founders and investors through industry events, mixers, etc.
Changes to other processes, such as due diligence and deal screening, can also be made depending on the ultimate optimization goal. The key here is to embrace the subjective and dynamic nature of deal flows and set up/reconfigure processes in a way that helps you meet your current business goal while also keeping them agile and scalable.
How can you optimize your deal flow?
Your first order of business while optimizing your deal flow should be to organize all of your deal processes better. Efficient collection and storage of information reduces the chances of good deals getting lost in your desk clutter. It also allows you to run screening and due diligence checks and establish follow-up communication with the selected entrepreneurs much faster. A few other tips that can help you optimize your deal flow are:
Centralize All Inbound Communication
As mentioned, desk clutter might be a major reason for the inefficiency of your existing deal processes. When your leads aren’t organized in an efficient, easy-to-access manner, it becomes more difficult for you to extract the required information for screening and due diligence processes. Desk clutter also hinders communication between your firm and its portfolio companies. When all leads aren’t efficiently organized according to parameters like quality, business sector and follow-up status, it becomes more difficult for you to reply to entrepreneurs on time and move their startups along the deal flow pipeline in a smooth and efficient manner.
Centralizing all inbound communication is an excellent way of cutting through desk clutter and moving towards a cleaner, more organized deal flow. Any competent deal flow pipeline is expected to receive leads from several sources. All of these leads need to be meticulously extracted from each source and put on a firm-wide platform. These leads can then be organized according to various custom parameters like source, follow-up urgency and proposed funding. It is also important to collate all incoming emails and messages onto one cross-referenced information directory. This saves you the hassle of going through long email threads every time you follow up with one of your startups.
Monitor The Performance Of Your Deal Sources
While network referrals are considered the best source of quality deals for VCs, that might not always be the case. How effective a deal source is for you depends on several factors, including your own portfolio requirements and market trends. For example, if you’re looking to build a fresh portfolio by acquiring several small deals, web form applications and cold inbound communication might be the best deal sources for you. This is because these sources are capable of producing a steady stream of eligible leads that can be filtered through to find viable deal opportunities. On the other hand, if you’re looking for fewer high-quality deals, network referrals might be your best bet.
It is important to routinely assess the performance of each deal source to identify your biggest sourcing strengths and weaknesses. This can be done by monitoring KPIs like the average time it takes for a lead to get converted to a finalized deal and the total number of leads that go on to become successful deals. Based on a quantitative evaluation, each deal source can be supplemented with measures such as scout programs and proactive network building to help enhance their performance.
Indulge In Active Risk Mitigation
A key thing to keep in mind about VC portfolios is that risk analysis and mitigation aren’t one-off or periodic processes but active ones that help firms ensure the financial viability of their investments. Modern global markets are subject to dynamic risks that need to be monitored closely. VCs that actively analyze these risks become capable of building dynamic deal processes that can accommodate change and execute effective risk mitigation strategies when needed. If your market analysis tells you that the fintech sector might be about to hit a roadblock, you can diversify your portfolio by investing in other sectors (that are showing signs of improvement in the foreseeable future) to offset potential losses.
It is also important to pay attention to your legal risk mitigation processes. Newer sectors like digital data, fintech, and cryptocurrency are subject to frequent changes in relevant legislation, which compels businesses to follow updated consumer data privacy and security practices. It is important to ensure that every startup that passes your due diligence processes is compliant with the latest regulatory requirements. Companies that fail to do so might put themselves and your firm in legal jeopardy and severely damage your market reputation.
Streamline Your Networking Efforts
Social capital is one of the most important assets for VCs. Goodwill and a formidable market reputation go a long way in attracting startups to your firm and leveraging your referral networks to get access to the best deals. This makes it all the more important for VCs to indulge in active network-building activities. As Wharton professor Adam Grant notes in his book Give and Take, the best, most effective business leaders embrace a community-driven mindset where they believe in exchanging and not simply extracting viable business opportunities from their peers. Helping other investors find the right deals ultimately adds to your social capital and makes you more likely to be on the receiving end of such favors whenever needed.
Another important way in which you can streamline your networking efforts is by using digital platforms to network with other investors. An increasingly high number of VC investors are now using social media platforms to exchange valuable information. In the modern landscape, it is no longer viable to hold deal information close to your chest in hopes of having a competitive advantage over other investors. Active socializing on digital platforms through discussion forums, blogs, and digital consortia can help you get access to more high-quality deals.
How Deal Management Platforms Can Help
Deal management platforms are digital platforms that can help streamline and automate all your deal flow processes, from deal sourcing to due diligence. Intelligent deal management platforms like Zapflow are equipped with cutting-edge technology to help you automate all back-office tasks like extracting key information from deal applications and uploading it onto one central database in an easy-to-read format. Our explorer module further allows firms to crawl the internet for all relevant deal opportunities and produce a competitive analysis report to judge the viability of each deal. Zapflow can help you both optimize and customize your deal flow to fit all your business needs.
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