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Thoughts on Organic Deal Flow
The best kind of traffic to a web based business is organic traffic. It’s the best because it’s free, and usually means you are doing a lot of other things right that is driving folks to come to you directly or via word or mouth.
Similarly, the best kind of deal flow for a VC is organic deal flow. I tend to think of this as a spectrum. On the more organic side is when the founder and investor have a pre-existing relationship. Maybe you’ve backed the founder before, or have just known and shown mutual respect for each other for months or years.
Even if you are just meeting a founder for the first time, I think of deal flow as being organic when an intro is made by a founder that the investor trusts well before an active fundraise process has begun. This may even be from a founder that the investor has said “no” to before, as my friend Micah from Founder Collective has pointed out:
Highest form of VC NPS is deal flow from founders that we didn’t end up backing.
— Micah Rosenbloom (@micahjay1) September 24, 2019
Less organic deal flow is when it’s clear that an investor was inserted into a broad fundraising pipeline late in the process. It also occurs when an opportunity is surfaced by another investor. I should point out that these opportunities aren’t necessarily worse. We have made a number of investments that we are thrilled about that were referred to us by a trusted co-investor. But I think of these opportunities as far less organic.
When seed investing was less mature, there was a high degree of deal trading among early stage investors. This was because fund sizes were small, and many investors were relatively unsophisticated about leading early stage investments, so they liked to move in packs. A new entrant in the market could actually go a long way through deal trading or talking to other investors about founders that were making the rounds among the usual suspects.
But as the market has matured, I think this has been happening less and less. Funds have gotten more focused on their ownership percentage, and in order to get their ownership, they need to secure their slot in a round for themselves.
Investors will still syndicate rounds with one another, but it tends to happen a bit later in the process, and usually, the syndication happens between funds that were already around the table in the first place, vs. funds that are being introduced to the opportunity for the first time.
In this sort of environment, having organic deal flow is becoming more and more important. I think firms that have built their models around aggressive deal trading will struggle.
Those that have over-invested in getting to know founders and being active, helpful participants in the startup ecosystem outside of chasing specific deals will be more successful. We always look forward to syndicating opportunities with our favorite co-investors, but it seems like there have been fewer natural opportunities to do this in recent years.