When first investing in startups, the common advice is to invest in 20-30 of them so you can ramp up your pattern recognition, get experience to see what you like and don’t like, and optimize your chances of actually getting into a winner or two. As with any investing strategy, diversification among your portfolio is key to finding a winner.
Common ways to diversify is by sector, stage, experience of founder, estimated risk, and many others. For example, you may not want to invest all your capital into the travel industry in case that industry isn’t as lucrative as you’d expect over the next decade. And you wouldn’t want to invest in all first time founders either, as chances are high that none of them figure it out. You really want to spread out your risk and invest in a lot of different types of companies.
In our view, diversification starts at the deal flow level. All investments start as conversations. All conversations start from a source…deal flow.
What Is Deal Flow?
Deal flow is how you hear about new startups. It could be Republic or AngelList. It could be your local investor group. Maybe it’s an accelerator or a VC firm you’re friendly with. Regardless, if you invest in startups, you get your deal flow from something or someone. It’s important to audit your deal flow to make sure that it is diversified. If you only invest in crowdfunding deals, you’re limited to how well Republic or WeFunder attracts unique founders. Or if you only invest in YC companies, you may be investing in a similar type of founder raising in a similar way.
We suggest every private market investor, especially new ones, create a deal flow triangle to help maintain healthy diversification.
What is a Deal Flow Triangle?
A deal flow triangle is a framework to help make sure your top of funnel is bringing in very different types of founders. In it, you list the top three categories of deal flow that you rely on the most. Ideally, the categories attract totally different types of founders. I’ll give examples of two different investors and their deal flow triangles.
The Silicon Valley Investor
- Attends demo days of accelerators like Y Combinator and TechStars
- Speaks at founder conferences around the valley like TechCrunch Disrupt and SaaStr Annual
- Subscribes to dozens of syndicates on AngelList
The idea here is that accelerators will produce one type of founder and there’s an expectation around valuation, vetting, and quality of those founders. The conferences are the “outbound” tactic that could get the investor exposure to founders that never would have heard of them otherwise. And the AngelList deals are the typical insider baseball they never want to miss, even if they are a high valuation.
This is a good example of a deal flow triangle, but I would argue that even within the triangle, it attracts a similar type of founder; The one attracted to Silicon Valley insiders. This isn’t bad, but for the sake of this post, we want to be attracting the most random assortment of founders we can who are as dissimilar, yet impressive, as possible. So here is a different example of an investor just getting into the game.
The Novice Investor
- Looks at companies who are crowdfunding on Republic or WeFunder
- Focuses on companies out of their local university startup incubator
- Uses Seedscout to do outbound reachouts to founders that interest them from around the world
It’s hard to make the case that the founders come from the sources are all too similar. There is likely no overlap between #1 and #2, and #3 has more differentiated roots than the other sources, at scale. So even though this investor is a novice, their deal flow sources are already more diversified than their Silicon Valley investor friend. This will help over time as investing goes more global, far beyond Silicon Valley.
What’s Your Deal Flow Triangle?
As you think about your deal flow triangle, how are you making sure it’s diversified as it can be? Even if you use one great source, we encourage you to find at least two other types of deal flow sources so you’re getting exposure to all types of founders. Also note, this doesn’t need to be complicated. Think where you meet founders in your day to day life and this can be part of your triangle. Ideally, the triangle gets stronger and more informed over time but we all started somewhere. So the question is, where will you start? Let me know if Seedscout can help.