Deal (Flow) or No Deal

As an entrepreneur or angel investor, you may ponder what factors under your control can lead you to choose successful ventures. Every angel investor and venture capitalist has made regrettable investment decisions, and most entrepreneurs have at least one failed venture in their past. We try to learn from our mistakes, but what proactive steps can we take to reduce the probability of investing in or starting businesses that are doomed to fail? One answer is common sense to venture capitalists; however, I often find that entrepreneurs, and even angel investors, fail to recognize the value of deal flow.

Professional investors understand that money and deal flow are the key inputs of their business, as they are in the business of building investment portfolios, which diversify risk and seek alpha. For example, in order to build a robust portfolio of 20 early-stage companies, you may have to look at 800 business plans. These investors understand that the more deals they review, the better their chances of finding deals they like.

Most angel investors are looking to make a few illiquid investments in startups, and most entrepreneurs can only develop and manage one business at a time. Angels understand the high level of risk associated with these investments, but they represent only a small fraction of an overall portfolio, which typically includes stocks, bonds, and real estate. Entrepreneurs assume responsibility for the inherent risks of a new venture and relish the challenge of achieving a successful outcome. Too often, neither the angel nor the entrepreneur wants to look at hundreds of business plans before making a decision. They are too busy chasing alpha!

Nevertheless, deal flow is far more valuable to them than they may realize. Because they are not able to diversify their risk as effectively as the professional fund manager with a large pool of capital, making the right choice about a new business is paramount. And the only way to systematically improve their probability of successful choices is to increase their access to more opportunities.

If you are eager start a business or make an investment, you will pick amongst your available options. But what if you are not looking at enough options? Some startups have a great idea, but lack experienced management. Some talented management teams have lousy ideas or terrible market timing. Some ventures are so promising that a dozen other players are already vying for market share. Some ventures sound too good to be true, and if you dig deep enough, you will find the fatal flaw. If you have enough deal flow, you are forced to separate the wheat from the chaff. More often than not, entrepreneurs and angels make choices with too limited a set of opportunities.

If you have invested in a startup or founded a company, ask yourself: “how many business plans did I review or how many business models did I conceive and research before making a decision?” If the number was less than ten, and you have been wildly successful, then I commend you. If you have not been as successful as you would like, you might ask yourself: “how can I improve my deal flow before making my next move?”