Venture capital is often referred to as an apprenticeship business because so much important learning comes from day-to-day experiences. Yet, as an article published by the Business Development Bank of Canada (BDC) explains, you can shortcut the learning process by learning from experts: “Your learning curve can be shorter—and your results better—if you learn from pros who’ve already mastered key … ... read more
How To Increase Venture Capital Deal Flow
Jeffrey Glass, a partner at Bain Capital Ventures, an Ernst & Young “Entrepreneur of the Year”, and a member of Boston Business Journal's “40 under 40 list”, is akin to the vast majority of investors in that he funds only a very small percentage of the ventures he interacts with. He explains, “In one year I see over a thousand business plans and meet on average with hundreds of companies, but ultimately only invest in one to two.” As is the case with most investors, Glass sources most of his deals from referrals. As he rightly acknowledges, “It is really a referral business.” Maintaining high quality deal flow has always been important, but now, with a more rapidly growing & evolving startup culture, high volume (& high quality) deal flow through referrals is more important than ever.
With only so many hours in the day, it’s most effective and efficient for investors to prioritize trusted referrals. Rosalie Seriese, an Investment Associate at AngelHubVentures, describes a common reality for investors, namely that firms such as AngelHub invest in a mere 0.5% of all deals they see. Of the five deals the firm funded in a recent funding year, four came via a trusted referral. The fifth investment received “an endorsement from a trusted source shortly after they contacted us.”
Referrals can materialize in many different forms. Effective investors exploit three powerful avenues in order to assemble referrals and increase deal flow.
Referrals from other investors
Investors are more likely to prioritize referrals over other inbound requests, largely in order to reduce information asymmetry. The immense uncertainty associated with investments (especially early-stage investments in the prototype stage) is challenging to cope with. A seal of approval from a trusted investor reduces risk and increases an investor's motivation to vet the referral further.
Investor-investor referrals are a powerful avenue to source new deals and increase deal flow. The ultimate value of investor-investor referrals depends on the relationship strength between the referring and referred investor. If relationship strength is high, referrers are most likely to be in tune with the specific strategies, objectives, and tactics of referred investors.
Investors who have co-invested together in the past, for example, typically have high relationship strengths. Shane Luke, Strategic Partner and Technical Advisor at Relentless Pursuits Partners, explains that the utility of a referral increases if it comes from someone an investor has co-invested with in the past. The investors have an established relationship and are in a prime position to determine which potential investments align with one another's investment philosophies. Using Affinity, investors are able to determine the strength of their relationships with other investors and determine which investors are best suited to provide referrals to lucrative business opportunities.
Referrals from portfolio companies
Portfolio companies can function as an equally valuable source of referrals for venture deals. Referrals of this flavor are especially valuable if two conditions hold. First, if a referral comes from a portfolio company that the investor has profited from in the past, it will typically have high utility. Profitable portfolio companies typically best understand what their investors are looking for and whether potential investments align with investors’ interests and areas of expertise.
Second, if a member of the portfolio company is referring a company in its same industry or area of expertise, the referral will typically have high utility. Mark Bivens, Venture Partner at Truffle Venture Capital, explains, “If a member of one of my portfolio companies recommends I meet someone, I will most likely accept a meeting without hesitation. My portfolio company knows its market space better than I, so if they find a fellow entrepreneur’s startup proposition compelling, this is tremendously valuable insight for me which creates some of the most relevant deal flow.”
Referrals from service providers
Service providers such as lawyers, banks, and accountants are an oft-overlooked referral outlet. David Nevas of Edison Venture Fund explains, “service providers are another great way to get referred. Lawyers, accountants, banks, consultants… who have worked with us frequently in the past generally have a very strong sense of fit."
Nevas explains that there is a tremendous benefit for both investors and service providers in developing strong relationships, “Many of these service providers also use referrals as a way to differentiate themselves to companies, so it can be worthwhile to build your network with these folks even if you don’t currently have a need for their service.”
Referrals can be a galvanizing force in the investment world. Exploit multiple avenues for referrals. The key to success is to increase your relationship intelligence so your firm can benefit from increased and high quality deal flow. Map out your network using Affinity and find your most powerful connections. Don't simply look for investors who can connect you to potential portfolio companies. Look for referrals from existing portfolio companies, service providers, and other parties that work frequently with entrepreneurs and relevant other ventures.
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