LPs often ask and fund managers often brag about their deal flow. They usually quote a large number of deals per year. Though quantity matters, it does not give a full picture of a fund manager’s ability to build a great portfolio. A large number alone can even be misleading.
When a fund manager only discovers a subset of all possible deals, there is a possibility that they will miss an opportunity to get into a great one. The more random the distribution of deal quality, the greater that possibility. Fortunately, the distribution of all possible deals is not even close to random. Some sources have much better quality deals than others. In general, deals sent cold through a website link are least likely to be good quality. Deals being quietly done by other VCs are most likely to be good quality.
Even the most inquisitive fund manager will miss some on-thesis deals. However, if they are accessing deals from the best sources, it hardly matters. Their missed opportunities will mostly be bad quality deals. Assuming a fund manager only counts on-thesis deals as their top-of-funnel deal flow, the number is more indicative of the breadth of thesis than the ability to build a good portfolio.
Loss of sourcing good opportunities creates inefficiency in building a great portfolio. Better fund managers have a smaller sourcing loss and therefore a somewhat better probability of the best possible long term returns.
These are the sources where most VC fund managers find deals, in order from lowest to highest probability of having a quality deal.
Cold inreach
Outreach based on databases (PitchBook, Crunchbase, LinkedIn, others)
Pitch events
Angel groups
Conferences
Accelerators
Other startup founders
Other VCs
An LP can get a somewhat more meaningful measure of a fund manager’s sourcing ability by asking for numbers on a per-source basis rather than a single top-of-funnel count.
Another measure of deal flow quality is to look at co-investors in the same round and investors in follow-on rounds. These are measures of relationships with other investors, which is the highest probability source of good quality deals. It is a second degree measure but more helpful than a single top-of-funnel count.
Even those measures can be misleading. Some fund managers produce the best alpha by finding diamonds in the rough. They are able to get better probability/price ratios in deals. No measure of deal flow will favor such managers. Focusing on deal flow numbers can cause LPs to miss the best managers.
Fund managers get a clue that the top of their funnel is catching a large portion of available deals when they see the same deals through multiple sources. Another clue is when they start to see many examples of roughly the same company ideas.
Fund managers can improve their ability to see good deals by looking for past deals that they never saw, then brainstorming other approaches to sourcing that would have found those deals.
Currently, gene tech is unappreciated by private equity and VC investors. Even the most promising genomics startups struggle to raise. Aside from this giving investors great pricing, it means that they need to make themselves known to as many investors as possible. If the CEO is even minimally competent, the company will be visible in at least one of those deal sources.
In the current environment, a gene-tech-focused fund manager can easily access the best on-thesis deals.