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The Four Categories of Deal Flow
How founders and investors can find arbitrage in deal flow...
Matthew Kee
August 24th, 2024
If you’re new to this newsletter, click here to access the rest of my newsletter articles such as the “Why We Passed on this Startup” series, reflections on investing, and tactics on winning in the market. Now, onto today’s post!
Investor deal flow is unsearchable. And yet…
An investor’s job is not to invest in every deal but rather give themself the opportunity to invest in every deal.
On a recent Summer weekend, my family and I visited some friends at their cottage in Northern Wisconsin.
My two older boys had the opportunity to fish in the lake that was nestled near the cottage. My boys caught a few fish. Then, my son asked me, “Daddy, how many fish are in this lake?”
It was a great question with an unsearchable answer. We will never truly know how many fish are in the lake. Did my boys catch 2% of them, 47% of them, 80% of them, or 98% of them?
Investor deal flow is the same way. For an investor, there is no way to truly know how effectively they are indexing the startup opportunities in the market.
This market inefficiency is one part excruciatingly frustrating but on the other hand, represents a tremendous arbitrage opportunity.
✅ An investor’s job is not to invest in every deal but rather give themself the opportunity to invest in every deal. ✅
The Four Categories of Investor Deal Flow
✅ Startups that an investor..
…chooses to invest in.
…chooses to pass on.
...is aware of but doesn’t know about the fundraise, so they miss the opportunity to invest.
...is NOT aware of and discovers it after the round has closed, thus missing the opportunity to invest. ✅
Let’s go through some examples to see how this works in practice.
1) Startups that investors choose to invest in
Obviously, this category represents a small and selective minority of startups that an investor sees.
2) Startups that investors choose to pass on
This category represents the vast majority of startups that investor sees.
In the first two categories, the investor becomes aware of the startup and thus has the control to react to it. The investor has the control to say “yes” or “no.” The investor wants to their deal flow set to be in Category 1 and Category 2 as much as possible.
The next category, Category 3, is ripe with opportunity for both investors and startups.