If you are interested in pursuing a career in venture capital, you need to know how to source deals. Sourcing deals means finding and evaluating potential investments in startups that match your fund's criteria and strategy. In this article, we will cover the essential steps to sourcing a venture capital deal, from identifying prospects to closing the deal.
The first step to sourcing a deal is to define your investment thesis. This is a statement that summarizes your fund's goals, focus, and value proposition. Your thesis should guide your search for startups that fit your criteria, such as stage, sector, geography, and impact. Your thesis should also reflect your fund's competitive advantage, such as your network, expertise, or track record.
In venture capital, the essence of a fund's thesis lies in its ability to encapsulate the unique position it holds within the market and its unparalleled access to top opportunities. A seasoned venture capitalist must be acutely aware of their strengths and seize the opportunity to form a thesis that doubles down on these advantages. Conventional wisdom does not advocate efforts to improve your weaknesses in a landscape driven by the pursuit of outlier returns and the principles of the power law. Instead, the strategic approach is to harness and amplify your inherent strengths when deploying capital. Embracing this philosophy is the cornerstone of successfully crafting an investment thesis.
A successful fund investment thesis is one that retains its appeal and unique proposition through the cycle. If the thesis relies on a short window of opportunity to be successfully executed, chances are that the VC is simply playing a game of timing (or momentum) where very few have or can succeed. This is particularly relevant for longer duration sectors like deep tech, biotech and foodtech where, inevitably, the VC fund will face multiple sides of any given capital-economic-market cycle during the life of the fund.
It’s imperative that in deal making the message and value proposition is clear and unambiguous. Value identification by the counterparty is a core part of solidifying a successful deal close. Once it’s clear what you bring to the table it will be clear to the counterparty. Determining the value of that offering is then the next step which requires enrolling the other party in your vision.
A fund thesis should be heavily influenced by the fund size you have, or plan to raise, and by your unique angle in sourcing startups. As a rule of thumb, the smaller the fund, the earlier you'll need to go to build an access and investment strategy that makes sense for such size. You also need to make sure you have developed the right network and scouting tools to see the right fit companies at the right time to execute on investments. Lastly, especially in competitive deals, your unique selling point as a fund (part of the thesis) could be how you eventually win allocation
Get out into the market and make sure entrepreneurs like and respect you and your organisation. Word of Mouth travels like wildfire through the entrepreneurial ecosystem, so if you build a good rep - largely IMO by being fair, even in rejecting companies, giving useful, actionable feedback, you can get deal flow super fast.
The next step is to build your pipeline of prospects. This means creating a list of startups that match your thesis and have the potential to generate returns. You can source prospects from various channels, such as referrals, events, platforms, databases, and media. You should also leverage your existing relationships with founders, investors, mentors, and advisors to get introductions and recommendations. You should aim to have a diverse and balanced pipeline that covers different segments and opportunities.
I always consider diversity and balance when building a pipeline or deal warehouse. A well-rounded portfolio is built on exposure to different segments. This diversity not only mitigates risk but also positions us to capitalize on a wide range of emerging trends and engage with innovative startups.
The best way to build a healthy pipeline is to map all the key players in that ecosystem and connect with them. For instance, if you are looking for startups in spacetech, identify and connect with all the key stakeholders that make that ecosystem like the space agency, institutions that are conducting research in this area, universities that conduct study programs, incubators, accelerators, investor communities, startups, and industry associations.
Developing a pipeline requires a constant and coherent effort to identify companies that fit into the investment thesis. For every 100 companies contacted, probably only 10 of them will make the cut and probably only 2-3 will reach the investment readiness stage. This means building a pipeline is a process that requires discipline. It does not happen automatically or by chance
The best way to build a pipeline in venture is by being authentically visible and providing non-capital related value to founders. How do you create authentic visibility? Share insightful content, attend startup events, speaking engagements, attend demo days, podcasts, etc and the pipeline will build. Want to earn the respect of founders? Provide value outside of capital. Make investor and customer introductions. Provide operational support. Talk about them on socials. And do this without asking for anything.
I would always start my exercise with the founders. While you are already connected with the founders and have been monitoring their moves, you can easily predict whether or not their next startup will be a hit. To prepare my portfolio stronger, I tend to spend more time with the founders, physically, virtually or even tracking them. If you conduct your study properly, there is a feeble chance of finding a black sheep. It is always advisable to also collect some feedback from previous investors and mentors. Having diversity in your portfolio is always good, which is unlike of previous times where a specific investment funds was bullish on specific type of startup only.
Once you have a pipeline of prospects, you need to conduct outreach to initiate contact and establish rapport. You should tailor your outreach to each prospect, highlighting your interest, relevance, and value. You should also be respectful, responsive, and transparent in your communication. You should aim to get a meeting with the founders or the key decision-makers, where you can learn more about their vision, traction, and challenges.
The journey starts with thorough market research. This involves identifying emerging trends and sectors ripe for innovation. Networking plays a pivotal role; attending industry events and leveraging online platforms like LinkedIn can unearth promising opportunities. The next step is due diligence. Here, the focus is on evaluating the startup's team, product, market potential, and financials. It's crucial to assess the scalability and sustainability of the business model. Finally, the negotiation and deal structuring phase involves aligning interests and setting the groundwork for a successful partnership. Effective communication and a clear understanding of terms are key to a mutually beneficial agreement.
Want to conduct successful outreach to founders? Be your authentic self. What makes this startup interesting to you? Tell them. Keep outreach short, concise, and well-designed. Briefly introduce yourself and the firm. End with a definitive ask. Follow-up.
Elevating VC outreach involves crafting compelling, personalized messages that spotlight a fund's expertise and track record. Active social media engagement, warm introductions, and genuine interest expressed at networking events build meaningful connections with founders. Emphasizing the comprehensive value provided, including insights and resources beyond capital, strengthens the proposition. Lastly, following up promptly showcases consistent commitment to lasting relationships. In the dynamic venture capital landscape, authentic connections are pivotal for successful partnerships, serving as the linchpin for collaborative growth
When you’ve identified a company that fits your thesis, reach out and demonstrate tangible value. Join the dots in advance of a company’s funding round. Make customer introductions, list talent you can introduce who would be a good fit, identify companies in your network who would make a great partnership. All these help to win deals in competitive rounds.
Conducting effective outreach involves a consistent, thoughtful & authentic approach. - Clearly define the sectors, stages, & geographic regions that align with your fund's investment thesis. - Craft Personalized Outreach. Avoid generic messages. Demonstrating a genuine interest in their business. Highlight specific aspects of your fund that align with their needs & aspirations. - Communicate Your Value Proposition. Emphasize any unique resources that set your fund apart. - Maintain Consistent Communication. - Streamline the Due Diligence Process. Clearly communicate the due diligence process and timelines. Being transparent about what can be expected during the evaluation phase helps build trust & credibility. - Build respect and trust
After you have a meeting with a prospect, you need to perform due diligence to assess their viability and attractiveness. Due diligence is the process of verifying and validating the information and assumptions provided by the prospect. You should conduct due diligence on various aspects of the startup, such as the market, the product, the team, the traction, the financials, and the risks. You should also compare the prospect with other alternatives and benchmarks in your pipeline and market.
Evaluating the team, market opportunity, technology advantage, and GTM/path to commercialization is the most critical component of diligence for my sector (deep tech). I believe that too much diligence at the earliest stages of venture can be counterproductive. You have to think "what if this works" as opposed to "why won't this work" - big picture thinking very critical at the earliest stages.
It is important to recognize that the traditional metrics of financial analysis are no longer sufficient in capturing the full spectrum of a company's potential for success. In this digital age, where online presence and marketing strategies wield significant influence, a comprehensive evaluation of a potential investment's digital marketing efforts is crucial for making informed and forward-thinking decisions. And yet, most VCs spend little time evaluating a company's digital performance and growth strategy. You can stand out be understanding digital marketing performance.
Have a scoring matrix. Be very clear on the factors and indicators that will deem a company as a investable candidate for your specific thesis. In my experience, it’s best to explore this scoring matrix when conducting Level 1 due diligence: review of the pitch deck and/or supporting material. This will help reduce the amount of meetings taken unnecessarily.
My first recommendation is to focus on sectors where you have a deep knowledge of the market mechanisms and products and services to be offered to that market. If you meet this condition, you will be in a position to assess the attractiveness and the viability of the business plan where you wish to invest. So, the due diligence starts from a pre-requisite: know what you are talking about, know how to valuate the benefits that can be achieved by the innovation you are prepared to invest in. Once you have got that, you are half the way. Then, check the patents can be defended, and finally be sure the management is credible and is committed to develop the initiative. Once you have these three factors in line, you are done.
Due diligence is a concurrent exercise. In earlier times, the investors did due diligence on the Balance sheet that formed the basis of their decisions whether to invest or not invest in an organization/startup. However, for me, Due diligence is much beyond the Balance sheet and financials alone. For me, an investor needs to invest his/her time to get intrigued about the business and the founding team. Understand their vision and targets in a more realistic and agreeing perspective. My suggestion is: - Start with the Business Model - Look at the client relations - Get deep in the Books - Get deeper into the persona of founders
If you are satisfied with the due diligence results and decide to proceed with the investment, you need to negotiate the terms of the deal. This involves determining the valuation, the amount, the structure, and the rights of the investment. You should negotiate the terms based on your fund's objectives, expectations, and constraints, as well as the prospect's needs, preferences, and conditions. You should also seek legal advice and documentation to ensure the terms are fair and enforceable.
We grant complete operational freedom to founders and refrain from getting any governance rights. We find it counterproductive to engage in extensive negotiations as pre-seed/seed investors, except for upside-oriented critical matters like valuation and ownership. Our approach prioritizes optimizing upside potential with minimal emphasis on any downside protection.
Both sides should be reasonable, realistic, and fair when it comes to negotiating a term sheet. Regarding valuation, we have benchmarks for what we like to see at the earliest stages - but are flexible given the nature of outcomes relevant within deep tech. If the negotiation becomes a problem, don't be afraid to walk away.
Being an earlysatge VC, we are not very much worried about fancy terms of the agreement. However, we are particular about the ownership, pro-rata rights and valuation to some extent. We think at earlystages founder should not spend months in negotiating, instead they should spend that time in building the business. We prefer standard terms with a room for some exceptions in some case. It saves time for everyone.
As a founder be cautious in getting caught up with moonshot valuations. Yes it matters but whatever the valuation it will be far more than you could sell at in all likelihood and getting the “right” investor always matters more than the highest valuation. You’d be better served taking a reasonable valuation and focusing more of your energies on limiting loss of board control and securing appropriate cash compensation component with a severance if you’re pushed out at some point.
If the company looks great for you, have a discussion with the founder about her expectations. If she is fairly close to market, great? If not, it may take a little more time to conclude the negations on valuation, control, and rights.
The final step is to close the deal and formalize the investment. This means signing the term sheet, the shareholder agreement, and other relevant contracts. You should also transfer the funds, receive the shares, and register the deal. You should also celebrate the deal and welcome the prospect into your portfolio. Closing the deal is not the end of the relationship, but the beginning of a long-term partnership.
Believe me, never think this is the last step. And if you do you will never close the deal. From the first meeting with any investor only think of closing the deal. You have to show extraordinary enthusiasm in your venture. Let me break it down with N analogy, the investors have obviously made their money, they are ok and are looking for or in fact willing to risk for the next big thing. Your venture needs to simply show that in every word, action, meeting and dream! Never forget this truth!
After securing funding, maintain regular communication with your investors! Keep them updated on your business progress, milestones achieved, and any challenges you may face. The problem with communication is the illusion that it has been accomplished. Success is not final, failure is not fatal: it is the courage to continue that counts.
Dear closing is the dessert of the lunch. This is indeed the actual start of the partnership and should be done in a way which makes everyone happy. The technical aspect is important, of course, but the psychological part is what counts. if the Founders/Owners and happy and motivated - the sky is the limit
Be so excellent that the funding finds you. I see many 'slide-ware' software startups. Unfortunately if these founders really believed in their vision and backed themselves with focused execution. Funding would not be a problem. Confidence is a 'pheromone' for investors As the old saying goes… 'Ask for funding, you get advice. Ask for advice you get funding.' Share your journey consistently. This can be a regular 'build in public' LinkedIn post and a short email update to a curated list of investors. If you are solving an interesting and big problem with an A-team, you will increase your investability surface area with the ultimate signal of excellence: Inbound interest from an A++ VC firm. Good ??
I believe that sourcing deals isn't the challenge. "Selecting" them is. I'm frequently asked how and where I source deals, but very rarely am I asked how I select deals. Given the hyper growth of the founder ecosystem, most VCs have a surfeit of deal flow. As such, the key to long-term success as a GP/fund manager is adhering to selection criteria that create discipline around your investment process.
Sourcing a successful venture capital deal involves a strategic process that begins with a keen eye for spotting promising opportunities. I'd suggest active networking within the startup ecosystem and maintaining an open mind and staying attuned to emerging trends as foundational steps for sourcing game changer deals for your VC.
Investors must remember that Founders are their customers. In order to source the highest quality deals consistently Founders must trust you, your company, and your process. This means transparency, constant communication, and honesty throughout the lifecycle of the evaluation. A quick no, educated diligence, and/or a strong relationship post investment leads to a better founder experience. Doing this consistently results in a better brand as a firm and therefore drives the most talented founders to your doorstep. Doing this is a long term play but giving "customers" the very best experience in any business is important.
Different stages of funding have different requirements. But effective storytelling is always the required skill set. At earlier stages, what narrative are you aiming for? Why? Why you? And most importantly, Why now? At later stages, what are the results saying about your thesis? Can they be improved? With what? More money? How can that assumption be tested? If it can’t be tested, what are you basing your assumptions on.