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Proprietary deal-flow isn’t dead and for good reason

Recent talk on blogs and in VC circles have created a false impression that ‘the end is nigh’ for so called proprietary deal-flow. Venture capital could finally transform into an efficient market place (for a nice overview see Klinger). Why give a VC exclusivity over an investment opportunity, denying other potential investors to submit better terms, and reducing the chances of a successful deal? Right? Well, maybe. But some nuance is clearly missing in this discussion.

Proprietary deal-flow is very much still here, across all deal sizes, and for good reason. It takes a huge amount of resources for an investor to properly diligence a deal. It only makes sense to invest these resources if there is a decent probability of winning the deal.

More transparency is not the enemy of proprietary deal-flow. In fact, more transparency can avoid the need for auction-type deal processes, and make closed deal discussions with a small group of investors a more viable alternative for more firms. While dealroom.co believes more transparency is good for the VC industry, not every VC deal needs to be managed hyper-competitively, or even happen in the public realm per se.

This may sound paradoxical coming from us, but can be made more clear with some context. See, traditionally companies had only two rather extreme alternatives when it came to launching a funding round or sale process.

On the one hand, the lucky few companies with significant incoming interest from potential investors, or an extremely logical trade buyer could afford to have (semi-)exclusive talks, and hammer out a deal relatively quickly, because the buyer would feel under pressure. And in such cases, often no advisor is used.

On the other hand, many companies would not be in the strong position where there is a clear buyer. In these cases, companies have no perfect information who the best buyers are. These companies would often hire an advisor to contact a large group of potential buyers, send out an information memorandum, and launch an auction-type deal processes (sometimes with the help of press leaks). The benefit of this is increased competitive tension and maximising the chances of a successful outcome, at least theoretically. The downside is that most buyers don’t like auctions (winner’s curse). Lack of real commitment from all sides can actually hurt the process, and once the competitive-dynamic loses momentum, the auction-process can back fire and even the remaining parties may lose interest. Also, an auction is not a good environment to build trust between investor and founder.

How can more transparency change this?

Platforms like dealroom.co give companies better information about who the relevant potential investors might be. This reduces the need for “going wide” and instead allows parties to run a more focused process. It also becomes less risky for founders to enter into proprietary deal discussions with a VC, because there is a fall-back option and platform to keep the buyer who has been given exclusivity in check. Instead of two extreme alternatives (exclusivity vs. auction), dealroom.co opens up an infinite range of intermediate solutions. Companies can also “test the waters” before officially launching a deal.

How would this work in practice? A company with a well maintained profile on dealroom.co would rather quickly gather a following of investors and potential buyers over time. These get a chance to educate themselves on the company. Over time, some of them will lose interest. The ones who are genuinely interested over a longer period of time will continue to actively follow you, and demonstrate true investment appetite by being both pro-active and re-active. These are the parties to focus on when launching a deal.

The bottom line is that more transparency is almost always a good thing. How this benefit crystallises depends on the situation. For companies, managing their online profile gives valuable insights into where they stand and what is the best route once the time for dealmaking has come.