Ding-Dong, the Deal Flow Model is Dead

Bill Burnham has up a long-promised piece on how the deal-flow model of venture capital is dead. There is, as he correctly argues, too much capital and too much competition in the venture industry for venture firms to sit by the stream like bears waiting for passing salmon. Yes, that approach worked for years — and it still works in some small markets and for a few (very few) marquee firms — but for everyone else the old deal flow model is no longer an option.

Why? Because deals get too competitive too quickly. And at least as importantly, by the time you see something it is either some deal you shouldn’t want, or it is a deal that has already been shaped by other venture hands into a form that does not interest you as an investment.
Bill’s alternative: Thesis-based venture investing.

This approach stresses taking the initiative to develop an investment thesis based on focused expertise and then using that investment thesis as the basis for a directed deal acquisition campaign designed to either ferret out those existing start-ups that fit into this investment thesis or to help create new companies that can take advantage of an identified opportunity.

While that may sound perfectly sensible, and many entrepreneurs can be forgiven for thinking that the preceding is what most venture investors were already doing (they were not), it is not easy to do. Picking a thesis and sticking to it is tough. It often forces you to travel more than seems optimal, as you look for deals that meet your newly-narrowed criteria. At the same time, it presupposes that venture investors’ have a solid idea what they should be investing in. The truth is, as many entrepreneurs have discovered to their chagrin and lost time, what VCs say they want is often uncorrelated with what they later invest in. Today’s hot sector is tomorrow’s dreg — and both often turn out to be the wrong place to invest.
Nevertheless, Bill makes some very good points, and his piece is worth reading. And while I generally agree with him, I think the structural changes required in venture personnel is going to make this a long-cycle change in the venture industry at best. I’d happily be proven wrong as I’m a doggedly theme-oriented investor to a fault, but that would be too easy, now wouldn’t it.