Deal flow
Deal flow refers to the rate and volume at which investment opportunities reach finance professionals, particularly those in venture capital, private equity, and investment banking. The term describes both the quantity of potential deals reviewed and the pipeline through which they arrive. Strong deal flow is widely considered essential for successful investing.
Origins and Development
The modern concept of deal flow emerged alongside the venture capital industry in Silicon Valley during the 1970s. In 1972, two firms that would shape the industry were founded: Kleiner Perkins by Eugene Kleiner and Tom Perkins, and Sequoia Capital by Don Valentine[1].
Eugene Kleiner was one of the "traitorous eight" engineers who left Shockley Semiconductor to found Fairchild Semiconductor in 1957. His technical network and industry reputation generated early deal flow for Kleiner Perkins. Tom Perkins brought experience from Hewlett-Packard and an eye for identifying promising startups.
Kleiner Perkins became the first venture capital firm to establish an office on Sand Hill Road in Menlo Park, California. Other firms followed, creating a geographic cluster that facilitated deal sharing and referrals. The physical concentration of investors and entrepreneurs accelerated deal flow throughout the region.
By the 1990s and 2000s, these pioneering firms had built formidable portfolios. Kleiner Perkins invested in Tandem Computers, Genentech, Sun Microsystems, Netscape, and Amazon. A mid-1990s Kleiner fund returned $32 for every dollar invested. Sequoia backed Apple, Cisco, Oracle, and later Google[2].
Sources of Deal Flow
Investment opportunities reach firms through several channels:
Network referrals generate the majority of quality deals. Research published by Harvard Business Review found that only about 10% of venture capital investments originate from cold outreach. Approximately 60% of closed deals come from the investor's existing network: former colleagues, portfolio company founders, or trusted professional contacts.
Portfolio company referrals prove especially valuable. Entrepreneurs who received funding often recommend other founders they know and respect. These warm introductions carry implicit endorsement from someone the investor already trusts.
Syndication partners share deals when they seek co-investors. A firm leading a round may invite other investors to participate. This exposes both parties to each other's networks. In 1999, Sequoia and Kleiner Perkins each invested $12 million for equal 12.5% stakes in Google, demonstrating collaborative deal sharing.
Professional referrals come from attorneys, accountants, and advisors who work with entrepreneurs. These professionals see companies at early stages and can make introductions to appropriate investors.
Inbound applications arrive directly from entrepreneurs. While most unsolicited pitches are rejected, occasional gems emerge. Strong firm reputation attracts higher-quality inbound deal flow.
Deal Flow Metrics
Firms track several key metrics to assess their deal flow quality:
Volume measures how many new opportunities enter the pipeline each week or month. High volume indicates strong market awareness and brand recognition among founders.
Relevance evaluates what percentage of deals match the firm's investment criteria. A high volume of irrelevant deals wastes time and may indicate messaging problems. If a healthcare-focused fund receives mostly consumer technology pitches, something has gone wrong.
Conversion rates track progression through the pipeline. What percentage of initial meetings advance to due diligence? How many due diligence processes result in term sheets? Low conversion at any stage signals inefficiency.
Source tracking identifies which channels produce the best investments. If portfolio company referrals consistently outperform other sources, the firm should emphasize that channel.
The Selection Process
Even top-tier firms reject the vast majority of opportunities they see. Successful venture capital firms may receive hundreds of business plans monthly but fund only 0.25% to 0.5% of them[3]. The evaluation process typically proceeds through stages:
Initial screening reviews pitch materials against basic criteria. Does the company operate in a sector the firm understands? Is the stage appropriate? Is the geography workable? Most proposals fail this filter.
Preliminary meetings explore opportunities that pass initial screening. The investment team assesses the founding team, market opportunity, and competitive positioning. Chemistry between investor and entrepreneur matters.
Due diligence involves deep investigation of promising deals. Financial analysis, customer references, technical assessment, and legal review all contribute. This stage consumes significant time and resources.
Investment committee review determines which deals receive funding. Partners debate the opportunity's merits and risks. Terms are negotiated with entrepreneurs who receive term sheets.
Proprietary vs. Intermediated Deals
Deal sourcing divides into two broad categories:
Proprietary deals are sourced directly by the investment firm. The investor identifies the opportunity through its own network and research without intermediaries. These deals typically offer better terms because competition is limited.
Intermediated deals arrive through investment banks, M&A advisors, or brokers. These opportunities are shopped to multiple potential investors. Competitive bidding tends to push valuations higher and terms less favorable.
The best firms cultivate proprietary deal flow through relationship building, thought leadership, and value-added services to portfolio companies. Sebastian Mallaby, author of The Power Law, noted that "network entrenchment, which gives you deal flow, is one thing that differentiates very successful venture capitalists from the rest."
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References
- Gompers, P., & Lerner, J. (2004). The Venture Capital Cycle. MIT Press.
- Mallaby, S. (2022). The Power Law: Venture Capital and the Making of the New Future. Penguin Press.
- Metrick, A., & Yasuda, A. (2021). Venture Capital and the Finance of Innovation. John Wiley & Sons.
Footnotes
- Kleiner Perkins. Company history archives. kleinerperkins.com.
- Fortune (2016). "How the Kleiner Perkins Empire Fell."
- Visible.vc (2024). "Deal Flow: Understanding the Process in Venture Capital."