My Secret Source of Deal Flow
It’s not demo days. It’s not AngelList. It’s not lawyers or bankers. It’s the stuff that happens behind the scenes.
Due diligence calls.
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I recently led a $2M Series A investment for my firm, Sigma West. It’s in a company that’s building a killer analytics and engagement platform (still private, announcement to come soon). I met the founder of the company (let’s call him “Andy”) about 2 years ago when I was doing due diligence calls on another analytics company. I was looking for info about how gaming companies were building their analytics tools and what they thought of the various 3rd party solutions out there. I knew a friend of mine had gone to be a PM at a prominent gaming company - so I asked him who was in charge of analytics. He referred me to Andy.
When I called Andy it was on the pretense of seeking his advice and information in an important investment decision. It was a back channel reference. It was not made by the company we were looking at, but it was made via a trusted mutual friend. This sets the stage perfectly for a completely open conversation. The other important note is that Andy was a clear rising star in the company, which is why he was leading a very important department like analytics. On the first call with Andy he told me candid and detailed feedback and problems with every vendor on the market. It was information I just hadn’t heard before. It was clear and succinct. He clearly had a phenomenal grasp of the space and had a crystal clear understanding of what these gaming companies really needed. He was years ahead of the rest of the pack in terms of his thinking. During the call, he also told me about some problems with the company we were looking at, and he explained to me why the system he built internally was significantly better. I believed it.
So, I was interested to learn more. We met for a sushi lunch in San Mateo. We spent most of the time talking analytics - talking about the system he had built. I was blown away. I had already looked at a dozen companies in the space, but nobody was doing what he was doing with his internal tools. At the end of the lunch I picked up the tab and asked Andy if he’d thought about going out on his own. I encouraged him to pursue building his technology for others and founding a company himself. I told him to call me if he ever did.
Two years later, he called me. And I invested.
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This deal came through a back channel diligence call. I believe that these calls have two very significant benefits that make them good sources of deal flow.
1) Pretense - in normal meetings with VCs and entrepreneurs, someone is always selling. Selling puts people on the defensive. Nobody wants to be sold to. In diligence calls, it’s quite the opposite. It’s a trusted mutual connection for the open exchange of information. The conversations tend to be very candid and opinions are shared freely. Nobody is trying to impress the other person - and as a result, both people are impressed.
2) Quality - any introductions for diligence calls are typically made to the smartest person about a particular subject. It’s not necessarily the CEO of a company, more frequently it’s the uber-smart director or VP that knows a subject at a deep level. People are inherently very good at assessing relative knowledge in other people. If you ask me for a contact who is very knowledgeable in tax issues, or legal issues, or freelance marketplaces, or the solar industry – I will have a specific and immediate response for each one of those. I will refer you to the best person I know (assuming I think it’s a valuable use of both people’s time). The same goes for any back channel reference intro.
Due diligence calls are an important part of deciding whether or not to invest in a company. The best diligence calls tend to be through back-channel references and intros. These intros are made to very high quality people and you start the call with a strong pretense to establish a good relationship. You’ll get a bunch of good information, and as a nice added bonus, the person you’re talking with may be about to break out and start a company. And when they do – you have the inside track.
The lesson for me as a VC is to treat every person you talk with as if they could be the next founder that you’ll back.