Raising venture capital isn’t as simple as showing prospective investors a flashy pitch deck and getting a check. Luckily for inexperienced founders, raising venture capital is well-trodden, with plenty of experienced help available to guide you.
We’ll look at the process and sequencing of raising venture capital from the investors' perspective by breaking down venture capital deal flow.
What’s Deal Flow?
Deal flow is the venture capital term for the horizontal funnel detailing the process and sequence of events that startups go through from start to finish. It’s a funnel because, on the leftmost side, there may be many startups under consideration at the onset. As the deal flow progresses, the firm narrows down candidates further and further until just a select few get the funds they seek.
Because of the stringent and rigorous deal flow process, founders must understand the deal flow from start to finish and be poised to succeed in each step.
We’ll look at each of those steps. For our purposes, we’ll assume that you (as the startup) already have a polished and comprehensive investment package and data room that you’ve run past an expert in the industry or other consultant.
The first step is sourcing; those in the credit and lending business also call this step origination. Here, venture capital firms solicit as many startup options for consideration as is practical. They’re casting a wide net, hoping to find the next multi-billion startup, so entry into the sourcing phase is easy but also the likeliest phase to get preemptively cut. If you are missing basic components of a pitch or otherwise have a misstep, you’re out before you start.
Funds and firms solicit startups in many ways, including industry networking, and through insiders. Increasingly, venture capital and startups are turning to matchmakers who directly source deals. These are great for the venture capital firm as they’re getting pre-vetted companies and even better for the founders as they’re taking advantage of a pre-screening and series of recommendations or improvements. They can also take advantage of a network that may not have existed previously.
During sourcing, venture capital firms review investment packages to get an idea of the firm and investment feasibility. Screening is often the first time the founders personally interact with venture capital, highlighting the importance of a quality investment package. Rather than a presentation to primaries, screening is usually done by a dedicated point of contact or lead. This isn’t to diminish the position, though, because that point of contact holds the key to moving forward.
During the screening, the lead clarifies questions and offers the founders an opportunity to demonstrate their passion and commitment to the company. Founders must rehearse and prepare for this meeting, as it proves the axiom that first impressions are everything. There are likely dozens or hundreds of candidate companies, so you won’t have long in front of your lead, so a single misstep can mean disaster.
At this point, likely half or more of the initially screened candidates are still in the pipeline. Rather than direct interaction between the company and the venture capital primaries or partners, the review is generally the lead pitching his picks on behalf of the best startups he saw.
Review is the most stringent phase; usually, only 10% move forward. Again, this highlights the importance of impressing your assigned lead, as his passion for your vision is critical when he pitches the partners.
4. Due Diligence
Due diligence is the deep dive phase. You’ve provided the investment package with broad-stroke outlines of your data and proposition. Now the firm goes deep into your data room and analyzes all statistics, research, and projections. They’ll likely also do independent market analyses, competitor assessments, and interview primaries in the industry.
This phase can take several months as the venture capital is exhaustive in its due diligence to mitigate risk and maximize its potential return.
5. Committee Review
The committee is comprised of venture capital fund primaries, principles, and partners. It also likely has consultants sitting in that represent industry professionals and experts. This committee pores over the due diligence the lead, and their team did, then makes a final determination. The founders may or may not be present during the review, so it’s best to have documentation that can represent your firm fully in your absence. The phase ends with a vote of yea or nay to funding the firm.
This is the terminus of deal flow and is simply the backend legal and administrative work that includes agreements and term sheets. It ends when the capital is sent directly to the startup, and the hard work can begin.
What’s the most challenging phase in deal flow sequencing for a startup? Many may think it’s due diligence, as the entire company is laid bare in front of a critical observer looking for faults or inconsistencies. Others may be nervous about public speaking and fear the screening stage.
In actuality, the most demanding phase is sourcing. Although it encompasses the most candidates, getting your foot in the door is the first and most critical step. Industry knowledge, network, contacts – if you don’t have these, you may not even enter the funnel.
Luckily, direct deal firms exist to help sourcing, but you must ensure that you put your best face forward. Ultimately, that direct dealer is staking their reputation on your worthiness, so they’re just as critical (or more) as the leads as you move along the funnel.