The Adrenaline of VC Deal Flow
Recently, my partner Prashant Matta and I were discussing the slowed pace of fundraising in Canada (a topic that’s been top-of-mind for many people as of late). We spoke about the impact that the lull in activity has had on our individual day-to-day operations as well as on our teams. Prashant thoughtfully observed that one of his priorities during times of reduced activity is not allowing inertia to take hold.
Which got me thinking: we talk a lot about investor psychology during times of heightened activity, but not about the inverse. What happens to VC behavior when the adrenaline of deal flow runs out?
In any enterprise sales process, understanding buyer incentives, motivations and psychology is key to winning deals. And fundraising is, ultimately, an enterprise sales process. The more you know about how your “buyers” think, the better prepared you are to succeed.
When the economy is strong and fundraising activity is rampant, investors and founders alike are busy. Most of the blog posts, advice columns and articles that have been written about investor psychology presume this heightened level of activity. Google “fundraising FOMO” and you’ll get pages and pages of advice how to leverage FOMO during fundraising.
But what happens when overall fundraising activity is low? What happens to investor behavior when VCs aren’t tripping over each other chasing fast-moving deals?
Let’s start with the 5 Stages of Deal Flow Grief:
1. Excitement
Believe it or not, VCs are generally excited when they get an unexpected break from deal flow. That’s because most investors don’t have nearly enough hours in the day to get everything done. Just like startups, VC firms build up a lot of “tech debt” over time, as customer priorities (i.e. deal flow and portfolio support) trump everything else. So when there’s a break in activity, we dive in with both feet to try to make progress on process improvements, infrastructure projects and catching up with other investors and ecosystem players.
Actual footage of top tier VC
2. Denial
The second stage of Deal Flow Grief is denial. As the period of low activity extends into weeks, VCs will often resist the urge to acknowledge it, instead trying their best to explain it away (“It’s Spring Break. It’s Easter. It’s the first week in May when startups historically upgrade their laptops…”). They’ll pretend that everything is normal when catching up with other investors, wary of signalling a change in their firm’s deal flow (“How am I? Totally slammed! So many deals right now.“).
3. Insecurity
After denial comes insecurity. “Am I the only one who’s deal flow is slowing? Am I missing out on deals that other VCs are seeing? Is it just my city/stage/sector that’s slowing down…?”
Crucially, this is the point at which a VC’s tendency to invest starts to diminish. Unsure of whether or not they’re seeing the best startups, investors will slow their pace as they second guess the merits of the new deals that they do see.
4. Panic
As the slowdown continues, some VCs — particularly inexperienced ones — may panic and make poor investment decisions (a behavior that’s not entirely dissimilar to when investors get caught up in FOMO during frothy periods).
Early on, this can manifest as deals that take place at higher valuations than they should (e.g. investments that occur with lagging high valuations at a time when valuations are broadly falling). Over time, the panic can result in VCs lowering their bar and investing in companies that wouldn’t normally meet their criteria. (This is especially common in cases where the VC has vocal LPs that are themselves inexperienced and exert pressure on the investor to deploy capital.)
5. Acceptance
Finally, there is acceptance: VCs eventually come to terms with the shift in deal flow pace and adjust accordingly.
At this stage, VCs actively communicate and set expectations with their LPs that activity has slowed, alleviating external pressure to invest in deals that might not otherwise meet their requirements. They may also start to make adjustments in anticipation of a prolonged slowdown. For example, we’re currently seeing some investors extend their deployment period (the time frame in which they can invest in new startups).
It’s worth noting that not all VCs can do this. Government VCs and some regional VCs, for example, have expectations that they will deploy capital regardless of changes in the macroeconomic environment. As a result, it’s not uncommon to see these types of investors deploy as much — if not more capital — at a time when angel investors and financially-driven VCs slow their pace to match the rate of deal flow.
So where are we now?
At this point, we’ve broadly reached the acceptance stage of Deal Flow Grief. The vast majority of investors globally have come to terms with the fact that we’re in an extended period of low activity. That doesn’t mean that VCs aren’t willing to invest in new companies (the vast majority — particularly at Pre-Seed and Seed — are). It does mean that their psychology around making new investments has changed.
In the acceptance stage of slow deal flow, VCs have by-and-large disassociated themselves from any external pressure to do new deals. They’ve calibrated with enough other investors to confirm that, no, it’s not just them. They’ve spoken with their LPs about the reduction in activity and have likely received broad buy-in to adjust their investment strategy accordingly.
The result? A creeping inertia to not make investments.
That’s right, during extended periods of slow activity, investors flip from a fear-of-missing-out to a fear-of-making-bad-investments (FOMBI?).
For startup founders who are fundraising, their are two consequential impacts of this inertia:
In general, VCs will no longer “round up” when receiving your pitch.
During periods of high activity, the adrenaline of deal flow causes investors to give you the benefit of the doubt on certain aspects of your pitch. VCs won’t skip diligence, but they can absolutely get caught up in the excitement and have their skepticism tempered. In periods of low activity, VCs can become even more skeptical, as they increasingly worry about making bad investments. Expect to have more questions asked and more of your assumptions challenged during fundraising meetings.
It’s harder to generate competition amongst VCs
As inertia sets in, investors slow their deal pace. This can mean more meetings with each investor and — crucially — more time between meetings (as VCs no longer feel the time pressure to rush into a deal). The reduction in pace, combined with some VCs stopping making new investments altogether, makes it harder for founders to generate competitive dynamics when running a high-velocity fundraising process.
“So…does that mean I shouldn’t try to fundraise right now?”
No, absolutely not.
First off, although we’re starting to see signs of a deal flow rebound in Silicon Valley, we’re likely two quarters or more away from a rebound in the rest of the world. Fundraise when you need to and don’t risk your runway waiting for a change in the fundraising environment.
Secondly, keep in mind that the vast majority of VCs want to make investments right now. VCs can’t generate returns if they don’t invest in startups and there’s a lot of dry powder in the market (they’re also really excited about AI right now!). The fact that VCs have alleviated the short-term pressure to invest doesn’t mean that they want to sit on their hands. It just means that they are going to be more cautious and thoughtful when making new investments. Good VCs, like my partner Prashant, are actively trying to resist inertia.
Finally, you absolutely need to bring your A-game when fundraising in this environment:
Make sure your deck, data room and supporting materials are ready to go before you take a single meeting.
Build up a substantial funnel of qualified target investors before you start your outreach. This is not the time to drip feed your process or take 5 meetings per week. Founders raising Pre-Seed, Seed or Bridge rounds should aim for at least 100 - 150 qualified target investors in your CRM; for Series A, at least 80 - 100. Your goal is to line up 30 - 40 meetings in week one.
Don’t play fundraising games. This is not the time for fake FOMO or other goofy approaches (I’ve seen too many of these recently).
If you haven’t fundraised before or your last fundraising experience was in the Good Times™ of 2020-2021, expect to have a very different experience than what you’ve read about or previously experienced. VCs are still looking to cut checks, but they’re slower moving and more cautious than during times of heightened activity.
Be prepared and stick to the basics. It might take extra work to overcome their inertia, but if you come correct you’ll get the result you’re looking for.