What if I were to tell you that in venture capital, much of the work done to generate potential investment opportunities is thrown away? That’s right. VCs only invest in 1% of deals that they come across despite spending hundreds of hours researching companies.
Given the low percentage of deals that make it through the funnel, the deal flow funnel structure should be studied and mastered to bring in the best possible investment opportunities. Whether that approach includes broadening your top-of-funnel approach for more leads or dialing in your investment thesis to increase deal quality, the funnel structure is the way to do so.
This guide walks you through how a deal flow funnel should look, ways to measure deal flow performance, and strategies to implement (such as partnering with a sourcing partner like Falcon River) to optimize it.
What Is a Deal Flow Funnel?
Thinking of a typical sales funnel is the best way to think of the deal flow funnel structure that venture capital firms, private equity funds, and other investors use. It’s how firms and investors analyze, manage, and evaluate potential investment opportunities.
The funnel starts with sourcing deals and includes all its stages, from generating those initial leads to narrowing down investment decisions and putting capital to work. While the top funnel deal leads to a low conversion rate of 1-2%, building a highly optimized funnel is still the best process for generating the most promising investment opportunities.
For example, Homebrew partner Hunter Walk says,
“You lose 100% of the deals you don’t see.”
And he’s right. Seeing as many opportunities as possible is always the better strategy, even if you win fewer deals this way. With that in mind, the typical funnel tends to be split into three phases: top, middle, and bottom.
Top of the Funnel (TOFU)
In sales and marketing, you cast your widest net at the top of the funnel. Ideally, you’d like to fill this funnel with qualified leads, but in many cases, unqualified leads will also find their way into your funnel. This is the name of the game.
But when it comes to deal flow, increasing the number of deals that make it to the top of your funnel can be beneficial. As Hunter Walk says, “I’d rather see 100% of the top seed opportunities and win 50% than see 50% and win 100%.”
A percentage of the top-of-the-funnel leads will move down the funnel. Any form of lead generation, such as outbound or inbound, is considered TOFU.
Middle of the Funnel (MOFU)
After leads are in the funnel, the review process begins to screen, evaluate, and further qualify these deal opportunities. This represents the middle of the funnel, including the deal screening, partner review, and due diligence stages of the deal flow funnel.
This stage is crucial because it serves as a bridge between the broad net cast during the sourcing phase and the focused, resource-intensive due diligence that follows. If the goal is to push more leads down toward the bottom of the funnel, increasing the percentage in the top and middle of the funnel is required.
However, avoid doing this without good reason. Unqualified leads will only increase your workload and lower your conversion rates.
Bottom of the Funnel (BOFU)
The bottom of the funnel is when a firm’s investment committee reviews potential deals, prepares a term sheet, and deploys capital. But the truth is, everything always comes back to the deal sourcing process in the deal flow funnel. If the goal is to maximize leads on the bottom of the funnel, prioritizing more effective deal sourcing strategies is the first step.
For example, if you source 1,000 deals and only 1% receive investment based on your thesis, you’ll end up with ten deals. While you can push more leads lower in the funnel, you’ll still finish with ten deals only at a lower conversion rate if they’re not good investment opportunities.
The solution? Try tripling your number of deals sourced. Think about the increase in successful investments if you can source 3,000 deals instead of 1,000. Even if your investment percentage fell by 50%, you’d still close 15 deals instead of 10.
How To Structure an Effective Deal Flow Funnel
Building a deal flow funnel starts with the deal source, as it’s the lifeblood of venture capital and private equity success. It’s all about finding hidden gems that have the potential to become the next big thing. However, because of the industry’s low success rates, doing so requires a high volume of opportunities to close deals.
VCs and investors use a variety of methods to source deals, including networking, attending industry events, receiving referrals from trusted contacts, and utilizing deal flow sourcing partners like Falcon River to find off-market opportunities.
The deal sourcing funnel is structured to maximize deal flow. In many cases, the structure can be broadly divided into inbound and outbound deal sourcing, with various strategies for each.
Below, we break down each stage of a properly structured deal flow funnel.
Deal Sourcing
We need to source potential investment opportunities to fill a pipeline with deals. This is known as deal sourcing and sets the foundation for the entire funnel. Without a steady flow of high-quality leads that align with the firm’s investment thesis, you’re left with impossible-to-hit KPIs, unused capital, or misaligned investments.
According to a study conducted by Harvard Business Review, on average, a VC firm considers 101 opportunities before eventually closing an investment with one. In the same study, HBR learned that VCs:
- Met with 28 of those startups
- Reviewed 10 of those startups in a partner meeting
- Conducted further due diligence on 4.8 of those startups
- Prepared a term sheet with 1.7 of those startups
The crazy part about it all? The average deal took 83 days to close, with more than 118 hours spent on due diligence during that deal cycle.
So, while it may seem on the surface that deal sourcing is just a broad way to generate leads, dialing in the process can save time, money, and resources while maximizing your firm’s ROI.
Deal Screening
After creating a deal-sourcing process that fills your pipeline with enough opportunities, it’s time to move down the funnel to the deal-screening stage. This is where VCs filter out unsuitable opportunities, allowing firms to focus on the most promising prospects.
During screening, VCs assess startups based on criteria like market potential, team strength, and competitive advantage. This stage often involves reviewing pitch decks and conducting preliminary evaluations.
However, the total number of deals in the funnel is immediately reduced by over 80% here. Sergio Marrero, Founder of RBL1 Ventures, estimates that roughly 15-19% of those opportunities, on average, reach the next stage of the funnel.
Partner Review
After proper screening is done, a meeting with the startup is requested. This meeting is usually conducted during the screening phase, but every firm takes a slightly different approach to screening deals. In the partner review phase, senior partners meet to discuss the top investment opportunities presented by the leads.
Sergio also outlines RBL1 Ventures’ partner review process. They estimate that 55-58% of deals screened will reach partner review. The number is a bit larger compared to other firms because they host a weekly partner review meeting where each startup is analyzed for about 10–20 minutes.
However, the selection becomes much smaller for the due diligence stage. Approximately 10–15% of the startups discussed are passed down the funnel.
Due Diligence
No investment from a successful VC can ever be made without thorough due diligence. From website and pitch deck review to detailed competitor analysis, this step can take anywhere between 1-10 weeks (on average, 4-6 weeks), according to RBL1 Ventures.
Because of the work required during due diligence, the percentage of deals that make it to this stage is low. Due diligence is the final checkpoint before a firm commits substantial resources to a startup. The objective is to ensure that all potential risks are identified and evaluated.
If your funnel is structured properly and deals in the due diligence phase have been sourced and reviewed correctly, the investment committee will review roughly 50% of them to make an investment decision.
Investment Committee
The investment committee phase is a decisive stage in the venture capital investment process. It is when the due diligence is meticulously reviewed, and a final decision is made on whether the firm plans to proceed with an investment.
Once due diligence is complete, the lead compiles all analyses into a comprehensive memorandum, known as the ‘IC Memo.’ Approximately 70-80% of startups that reach the investment committee phase receive investment. It’s common to see the conversion rates at high levels like this in many VC firms further down the funnel because, despite casting a wide net, they properly vet each deal at every stage of the funnel.
Once an investment decision is made, the firm moves forward to finalize terms and deploy capital, marking the transition from evaluation to partnership.
Capital Deployment
Capital deployment is one of the final phases of the funnel, in which funds are finally allocated to the startup. This phase involves strategic decisions about the size and timing of investments to maximize returns and maintain equity stakes.
According to Austin Josie, it’s crucial to clearly understand your financial capacity and willingness to assume responsibility before proceeding. This involves handling escrow fees and working closely with M&A attorneys to formalize the transaction. The risk level at this stage is medium-high, as costs are incurred, but the commitment to purchase is not yet absolute.
Post-Investment Management
Once the capital is deployed, the focus shifts to post-investment management, where the venture capital firm actively engages with the startup to ensure growth and success.
In many cases, firms will work with the startup to provide strategic guidance, operational support, and the leverage of networks to facilitate business development. Having a realistic transition and growth strategy is crucial for effective business ownership.
How to Use the Funnel to Maximize Deal Flow
All venture capital firms implement deal-sourcing strategies to build out their funnel and keep their pipeline full of investment opportunities to review. The easiest way to break down these strategies is by looking at inbound and outbound sourcing.
Inbound Deal Sourcing
Inbound deal sourcing is when you attract potential investment opportunities through marketing, personal brand building, or networking. These strategies should encourage startups to approach your firm in search of capital. Some inbound deal sourcing strategies include:
- Content Marketing involves creating digital content, such as blogs, webinars, and videos, that provides value and positions the firm as a thought leader in its sector. This can attract startups looking for knowledgeable investors.
- Networking and Events: Hosting or participating in industry events and conferences to build a reputation and network that encourages startups to initiate contact.
- Online Presence: Maintaining a strong online presence through social media and a well-designed website that clearly communicates the firm’s investment focus and success stories.
Inbound strategies typically account for about 30-40% of deal flow, as they rely on the firm’s ability to attract high-quality opportunities through its reputation and visibility.
Outbound Deal Sourcing
Outbound deal sourcing involves actively seeking potential investments through direct outreach and leveraging networks. This strategy can include:
- Cold Outreach: Identifying and contacting promising startups directly, often through email or LinkedIn, to express interest in a potential investment.
- Network Referrals: Leveraging relationships with other investors, advisors, and portfolio companies to gain introductions to high-potential startups. According to Affinity, sourcing referrals from other investors is a key strategy for increasing deal flow.
- Proprietary Research: Conducting market research to identify emerging trends and companies that align with the firm’s investment thesis.
Outbound strategies often account for 60-70% of deal flow. This more proactive approach requires firms to stay in touch regularly with founders and people within their network.
How Your Deal Flow Funnel Should Perform
Understanding and properly structuring the deal flow funnel is only the first piece of the puzzle. You also need to understand the funnel’s performance and how to accurately gauge whether it’s working as it should. Here’s what a well-performing deal flow funnel should look like.
Number of Deals Sourced
A robust deal flow begins with sourcing a large number of opportunities. On average, venture capital firms look at around 100 deals for every investment they make. This wide net is essential to ensure a diverse and high-quality pipeline.
However, the focus should be on quality over sheer volume. As Vakeesan Mahalingam suggests, measuring the quality of deals rather than just the quantity is crucial. This is how firms gauge whether their pipeline is filled with high-potential opportunities.
Deal Relevance
The relevance of deals within a venture capital firm’s funnel is another easy way to see how well it’s performing. Deal relevance is determined by how well a potential investment fits the firm’s criteria, such as industry focus, market potential, and team capabilities.
Allvue Systems highlights that a well-managed deal flow funnel should present opportunities that are not only numerous but also strategically aligned with the firm’s objectives.
For example, a firm that invests in women-led startups would not generate many deals if their deal sourcing included many startups with male founders.
Deal Variety
A diverse range of deals is essential for a healthy deal flow funnel, specifically how these opportunities are generated. For example, are most of your deal opportunities from referrals? Do you have a high-converting cold outreach strategy? Mixing different deal sourcing techniques is how the top firms always keep their pipeline full.
Funding Stage
Another way to see how the funnel is performing is to present a deal at the appropriate funding stage, assuming your firm has defined the stage in which it prefers to operate.
Ask yourself if the deal opportunities you’re generating fall within your preference. In many cases, the easiest way to see how your funnel is performing is to ask internal questions like this related to your investment thesis.
How To Measure Deal Flow Funnel Success
Deal flow success can be measured in several ways, specifically by looking at metrics such as conversation rate, ROI, time to close, and overall deal quality.
Conversions Rate
Conversion rates track the percentage of deals progressing from one stage of the funnel to the next. Each funnel stage will have a conversion rate from the number of deals sourced to your final investment total.
Analyzing conversion rates helps venture capitalists refine their strategies and improve overall efficiency. For every successful investment, the average firm should review around 100 deals.
Overall Quality of Deals
Assessing deal quality involves evaluating each opportunity’s potential based on market fit, team strength, and alignment with the firm’s investment thesis.
According to SaaStr, quantifying deal flow quality is crucial for ensuring that resources are focused on the most promising investments. High-quality deal flow increases the likelihood of successful investments and better returns.
Time to Close
Time to close measures the average duration it takes for deals to progress through the funnel to final investment. Shorter times can indicate an efficient process. However, it’s important to prioritize quality due diligence over being the fastest.
Superjoin mentions that tracking lead velocity and conversion rates can provide insights into the funnel’s effectiveness and help identify areas for improvement. Balancing speed with thoroughness is essential for maintaining a high-quality investment process.
Return on Investment (ROI)
Lastly, firms should consider total return on investment when analyzing their deal flow funnel. This measures the net profit generated relative to the initial investment cost. While this is not solely based on deal flow, it’s a good indicator of whether the current deal flow funnel is working or not.
Venture capitalists often assess the performance of their investments using ROI alongside other metrics like cash-on-cash return and internal rate of return (IRR). A positive ROI indicates successful investments and effective deal flow management.
How To Optimize The Deal Flow Funnel Structure
Continuously improving your internal processes is how you increase conversion rates and your firm’s return on investment. Here are a few ways to optimize the deal flow funnel structure to increase deal quality, decrease time spent sourcing deals, and improve your investment performance.
Streamline Your Deal Sourcing
When it comes to optimizing the deal flow funnel, partnering with a specialized deal flow sourcing partner like Falcon River can lighten your team’s workload while unlocking access to off-market opportunities. We keep your deal pipeline full of quality deals by:
- Learning about your specific investment criteria before searching
- Leveraging proprietary search technology
- Matching your investment parameters with available off-market deals within our network
- Connecting buyers and sellers to streamline the investment process
Think of Falcon River as a top funnel automation tool. Instead of allocating resources to various outreach strategies, you can shift team members down the funnel while we worry about keeping your pipeline full.
Leverage Proprietary Technology and Tools
Another way to optimize your deal flow funnel structure is through technology. Many VC firms can focus on three key areas: implementing CRM systems, utilizing AI and data analytics, and developing proprietary platforms.
Implement CRM Systems
Centralizing your entire deal management process should be a top priority. A venture capital-specific CRM system can do this, allowing users to manage interactions with potential investments from initial contact to final decision.
They’re more advanced with a focus on relationship intelligence due to the complex deal cycles. It’s much easier to maintain inbound deal flow using a VC CRM. Added flexibility and more advanced automation features help maintain a more efficient deal flow funnel.
Use AI and Data Analytics the Right Way
In 2024, trying to handle manual tasks without a boost from AI will have you falling behind in the coming years. It’s estimated that 75% of VCs will use AI to make investment decisions by 2025, according to Gartner.
Some notable tasks AI can help VCs with include automating deal screening, generating predictive insights, and performing real-time data analysis.
Develop Proprietary Platforms
Developing proprietary platforms can be costly, but this is where VC firms can really stand out. It’s like building a solution to solve a personal, internal problem. Ideally, these platforms integrate seamlessly with existing CRM systems to make data flow and decision-making easier.
Customizable and scalable, they can be tailored to fit unique workflows and adapt as the firm evolves. Leveraging such technology boosts efficiency, improves investment outcomes, and offers a competitive edge in the market.
Diversify Deal Sources
Many VC firms lack diverse networks, which limits their ability to source deals from founders. Instead, they get stuck relying on one specific deal sourcing strategy. But when this dries up, they’re left with poor deal flow.
Instead of just waiting for network referrals or founders to call you, implement various techniques. Whether that is creating LinkedIn content or cold emailing founders, there’s always a new way to generate deal flow that’s likely unexplored within a firm.
Monitor and Track the Correct KPIs
Monitoring and tracking the right KPIs can help you correct course if deal flow is struggling. Without looking at the right numbers, creating a reliable feedback loop within your firm is impossible.
Instead, track and regularly review the number of deals sourced, conversion rates at each stage of the funnel, and deal quality based on alignment with the firm’s investment thesis. This will allow you to make data-driven decisions, adapt to market changes, and improve investment outcomes.
Automating your Deal Flow Funnel with Falcon River
If sourcing new deals is challenging or you keep falling short on your key metrics, consider automating the top of your deal flow funnel by using a deal-sourcing partner like Falcon River.
Falcon River excels in identifying and securing off-market opportunities, which are often overlooked by traditional sourcing methods. This approach not only increases the quantity of deals but significantly enhances their quality, allowing you to focus on the most promising investments.
Instead of relying on outreach strategies, Falcon River connects you directly with business owners, simplifying the deal process and increasing the likelihood of successful transactions. Request a meeting to find out how it all works today.
