Anatomy of a Series A Deal: Part I – Sourcing
I have to give credit to “Dave” the anonymous commenter on my partner Jeff Bussgang’s Sept 23 Blog Post, who complained that venture capitalists’ blogs “seems like a buncha crap happening inside an echo chamber, circular praise, recycled insights and so on…” He wrote that he hoped “somebody will be inspired to write about the anatomy of a deal, the mechanics of evaluation and all of that.” Dave – not sure I’ll hit all you have asked for, but am happy to give some glimpses of what can often be a very opaque process from the entrepreneur’s side.
Let me start with the disclaimer: what I am about to write is my own opinion and does not necessarily reflect that of my firm and certainly may not reflect the opinions of the greater venture capital community.
This is going to be a long post, so I will split into multiple entries.
A venture capital investment process comprises the following steps: sourcing, preliminary assessment, due diligence, negotiation of the deal and finally, a formal closing of the investment signaling the deal is completed.
- Sourcing – is the lifeblood of a VC firm; without a steady stream of high quality deal flow, firms won’t be able to make great investments and will become irrelevant to the best entrepreneurs who want to see a pattern of good investment judgment in their VCs. While each firm and each partner have their own proprietary strategies for finding deals, it’s still more art than science.
Sourcing strategies are both proactive and reactive. VCs track forward-looking trends and often put like-minded entrepreneurs together to evaluate ideas and form new companies. But by far most of the investments I have seen made have been in reaction to great ideas by innovators. I suspect there is an inverse relationship between VC-originated ideas and new company success rates, but I’ll leave that alone for now.
I reckon that VCs who proactively chase leading edge concepts, put themselves in position to meet the next crop of great entrepreneurs. And by showing (hopefully sincere) interest in their domain specialties, such innovators are more likely to want to work with those VCs. Make sense?
So, how do VCs find deals? In my experience, the predominant method is via personal recommendations directly to the VCs; the entrepreneur or someone close to them has worked the firm or VC before, or knows the VCs, professionally or socially (Another VC partner, lawyer, accountant, fellow board member, etc). Led by the MIT 50K, the business plan competition, has brought an American-Idolesque tenor to direct approaches and many VC firms participate in various annual contests. (we do!). The final categories of deals include over-the-transom submissions (email, snail mail) and broker-introductions. We have made investments that came “blindly” via email or post, from folks we didn’t know before – but to be honest, the numbers are very small.
And while I look at each and every proposal I receive, I have to admit that I have never funded (nor my firm to the best of my knowledge) a Series A deal referred by a banker who was being paid to market the deal. While some of my best friends are i-bankers, I bristle at the notion of (a) being part of an auction to get the highest price for a first round and (b) don’t think they add any value at that stage. The excuse I have heard is that the bankers have the connections to the VCs that first time entrepreneurs lack; i say that’s baloney – especially because those bankers are basically cold calling a group of VCs they don’t know in order to cast a wide net – and that act of spraying and praying fundamentally tarnishes the reputation of the company. If you don’t know VCs – try email, phone, US mail, fax – exhaust all other methods before resorting to a banker.
Next up – Part II, Assessment