As the younger generation has grown up and developed not only a taste for investing but also a keen ... [+]
Deal flow is a term commonly used in venture capital and investor circles to reference the number of startup pitches or potential deals that reach investors.
In venture capital, the common rule of thumb says that for every 10 startups backed by the firm, only one will go forward and become a large, profitable company–or if they’re lucky, a unicorn. The idea is that the one company is meant to make up for the money lost on the other nine companies–a risky gambit, no doubt, but one with the potential to reap significant rewards if the startup proves itself and the investors are able to exit. Investing at lower levels, such as the angel level, the ratio is even more skewed, with some angels suggesting only 1 in 100 portfolio companies will go on to deliver returns to early investors.
Family offices often play by a slightly different set of rules. Rather than investing out of profit motive, most families invest their wealth in order to preserve and grow it, keeping the family legacy going and ensuring that there is a comfortable cushion–or perhaps a mattress, in keeping with the dollar amounts usually involved–for future generations. This means that for decades, family offices have given venture investing a wide berth, preferring private equity, which invests in companies that are maturing and generally close to either an IPO or an acquisition.
As the younger generation has grown up and developed not only a taste for investing but also a keen understanding of new technologies, venture investing in family offices has grown. However, new as it is, setting up the initial pipeline to source potential portfolio companies can prove difficult.
Getting Started With Startup Investing
It’s possible, particularly in smaller investing circles, to get referrals from people in your network–whether they’re professional investors, other entrepreneurs you’ve worked with, or trusted friends. These are likely to be strong leads, which will introduce you to high-quality startups, most likely vetted by other investors and with solid business models. This kind of deal sourcing is known as inbound deal flow–when the deals come to you.
Initially, this flow might be small, but as you begin seeing pitches, closing deals, and making your first successes, the inflow of startups coming in search of funding is likely to grow exponentially. Some of the world’s top investors have seen thousands of pitches, and the Y Combinator startup accelerator invested in 84 startups in its Summer 2019 cycle alone. There are countless startups out there in search of funding, vastly outnumbering the availability of investments VCs are willing to make. This is why inbound deal flow is much more common, and often comes in staggering volumes.
In comparison, outbound deal flow involves actively seeking out certain investment prospects. There are several different ways in which a family office can reach out and begin making deals:
- Taking Straight Equity: You will have to negotiate terms and decide how much you are willing to give for a portion of a company.
- Putting Money in a VC Fund: You can become a Limited Partner (LP) of a VC fund or angel fund–effectively a form of investment management where you put your trust in the managing partner.
- Equity Crowdfunding: Certain platforms will allow you to invest in a private company (generally at a very early stage) in exchange for equity. It’s a Kickstarter concept, but instead of getting an automatic pre-order, you instead receive a stake in a startup. Examples of such platforms include AngelList, CircleUp, and Fundable.
- Co-Investing Through a Syndicate: Investing in a startup alongside another family office not only dilutes the risk, but allows you to free up money to invest in other projects. Multi-family offices, who usually have relatively less wealth to play around with, often engage in such co-investment deals by contacting all the parties and arranging for the deal to be brokered.
In these ways, it is possible for a new venture investor like a family office to begin investing in startups. Often, the journey starts by relying on more experienced investors to kick things off.
Building Your Own Base
Eventually, you may want to stop taking a backseat during the process and set up an independent pipeline. With time, care, and reputation building, this is likely to happen organically, but there are still some extra steps that can be taken to speed up the process.
The rise in family office impact investing has also enabled investors to find a closer fit with prospective investments and companies that could align with them. Well-structured impact investments that have been through proper due diligence can offer both market related financial returns while being impactful on a social or environmental level. This way an investor can find investments that also align to their value system or greater purpose. Get in touch with industry associations, such as European Venture Philanthropy Association, Asian Venture Philanthropy Network to hear more about local approaches.
Another step is keeping an eye on crowdfunding sites like Kickstarter and Indiegogo for potential portfolio companies to start monitoring. Often investors monitor interesting companies for a considerable amount of time before deciding to invest. This is why keeping in touch with startup news is a must, and this can be done with the help of daily newsletters and feeds. It can also be helpful to get involved with forums and networks of investors, to take advantage of the grapevine and access a large volume of deal flow at once.
Also take a look at the portfolios of top-performing and boutique venture capital firms in your network for deal ideas. Many worthwhile investment prospects can also be found through the demo days of incubation and acceleration programs, and to a lesser extent, pitching events. Together, these are sure to provide an ample flow of potential deals.
While it’s not necessary to invest in 100 startups at once as the angels suggest, it is best to explore as many options as possible before making an investment decision–not only to make sure that you are picking the cream of the crop, but also to hone your own startup investing skills. Savvy venture investing is a specialized practice, and the necessary know-how can really only be acquired by seeing as many startup pitches and decks as possible, and taking note of things like scalability, business model, and founder experience.
