The venture capital industry is governed by the Pareto principle. That is, approximately 20% of the companies in a venture capital portfolio return 80% of the value. Marc Andreessen has explained, “The key characteristic of venture capital is that returns are a power-law distribution…We see about 3,000 inbound referred opportunities per year we narrow that down to a couple hundred that are taken … ... read more
Expert Tips for Venture Capital Deal Sourcing
The venture capital industry is governed by the Pareto principle. That is, approximately 20% of the companies in a venture capital portfolio return 80% of the value. Marc Andreessen has explained, “The key characteristic of venture capital is that returns are a power-law distribution…We see about 3,000 inbound referred opportunities per year we narrow that down to a couple hundred that are taken particularly seriously…There are about 200 of these startups a year that are fundable by top VCs. … about 15 of those will generate 95% of all the economic returns … even the top VCs write off half their deals.”
It’s all about finding the diamonds in the rough. And it’s not a task for the faint at heart. According to data from Teten Advisors, the median investor in private companies reviews over 80 opportunities in order to make 1 investment. The same research also revealed that closing a single deal requires an average of 3.1 full-time investment team members—and 20 meetings with management. That’s a lot of heavy lifting!
Here are three expert tips for super-charging your deal sourcing capabilities.
1. Be transparent about your investment thesis
Traditionally venture capitalists have kept their investment strategy and thesis under wraps, sharing only minimal vague details. According to David Tenten, a Partner with ff Venture Capital, that model is now flipped. Venture capitalists have started blogging, becoming more active on social media, and even posting analyses of their target investment demographics online. According to Tenten, “These investors have found that openly discussing their investment theses increases their perceived expertise and trustworthiness, and thus generates dealflow.” It’s all about creating a more welcoming brand that is transparent about the type of startups that it wants to engage and partner with.
2. Incentivize entrepreneurs with value-added services
Many venture capitalists wait to offer entrepreneurs value-added services until after the check has been signed. The most effective ones, however, start adding value from the get-go. They initiate the relationships by “giving”. According to network expert, Adam Grant, "Givers create more robust and extensive networks because they have established a history of giving to others without expecting anything in return.”
The most effective venture capital deal sources go beyond hosting entrepreneurship events or meetups to the general startup population. They focus on spearheading exclusive events that attract key thought leaders and industry experts. Top Israeli Venture Firm, Aleph, for example, has hosted a workshop titled “Aleph.bet Product Management” for promising entrepreneurs and prospective portfolio companies. The description states, “Aleph.bet is a growth workshop where executives of companies with 10M+ of users or $10M in revenue, share their experiences with a select group of executives from companies with 1M+ users by discussing case studies and holding topical discussions.” This is not your typical startup mixer with pizza and soda. It’s an exclusive event that is handcrafted for Aleph’s target demographic.
3. Build a global community
Strong relationships are at the core of all successful venture capital investments. One of the most effective ways to build and grow relationships is by fostering a global community. According to research published by Harvard Business School, although the best-performing venture capital funds are based in three major hubs—Silicon Valley, Boston, and New York—, their best-performing investments are headquartered outside those concentrated regions. Their early stage deals located outside the venture capital hubs outperform other investments by approximately 4%, while their later stage deals located outside the hubs outperform other investments by approximately 5%! It’s impossible to know where to invest geographically without being strongly embedded in a global community.
500 Startups is one of several investment arms that has doubled down on forming a global community. Bedy Yang, a Managing Partner at 500 Startups, has explained, “With more than 1,800 investments in over 60 countries, building a global network has been one of the most effective ways of generating inbound deal flow.” The accelerator hosts roadshows such as “Geeks on A Plane” that enables partners to interact, build relationships, and partner with key local players.
Effective sourcing is part and parcel to success in venture capital. Mark Suster, a serial entrepreneur and current managing partner at Upfront Ventures, reflects, “One of the major calibration pieces for me was where to find deal flow. As a VC you want to feel like you have “proprietary sources” of deal flow. Otherwise you’re a stock picker, which in this business isn’t a good thing.” By prioritizing transparency, acting as a “giver”, and building a global community with relationship intelligence tools like Affinity, you’ll create proprietary sources that allow you to find the hidden gems.