*This post is a part of a series of posts we have written. To start from the beginning, click [HERE].
The first step to being good at funding high-quality lending opportunities… is being good at seeing them.
“Seeing” the best deals is a massively important metric, even if you’re not investing in all of them.
Sourcing is an important leading indicator of future success and is what gives us access to building a strong benchmark of “what a great deal looks like.”
Bessemer Venture Partners publishes their anti-portfolio, demonstrating how much they value seeing all of the best deals, even if they can’t do all of them.
The only thing worse than passing on the next great company is not seeing it at all.
Here’s a link to Bessemer’s page. If you haven’t read it yet, you should, it’s hilarious:
https://www.bvp.com/portfolio/anti-portfolio
It takes a long time to start building great deal flow. For us it’s been 4 years at CoVenture, and even longer than that in our individual careers before CV.
Below are a list of channels we use to ensure we’re getting enough swings at bat.
Venture Capital Network
We have become known among our venture capital network as a co-investor that understands how lending companies work.
Venture capitalists know us as a firm that is able to fund loans originated by online lending platforms. Often, when they are thinking about investing in the equity of an online lender, they will send the company to us to ask our opinion.
It’s selfishly helpful for us to help our VC friends who wants the opinion of a potential lender who sees a lot of similar companies. Because if we demonstrate our willingness to help, we’ll keep being shown new deals.
More broadly, identifying potential co-investors in a specific industry, sector or space is valuable, especially if they are better collaborates than competitors. In VC this is easier to do than normal since most funds focus on “investing at once stage, and one stage only.” Or in just one part of the capital stack (preferred equity).
Our LP Base
Like many new firms, we initially raised capital from high net worth individuals, family offices, and entrepreneurs. We have over 250 investors across our various vehicles and many of them send multiple deals per year (or month!). It’s not hard to see how that adds up to a lot of deal flow.
The quality of LP deal flow ranges. Some use us as a way to defer pitches that were sent their way that they don’t want to do the work on, or to which they feel awkward saying “no”. But other LP’s of ours are totally dialed into the credit world, know our thesis well, and feel that if they can help us find the best deals it’ll help their own investment performance. These are our favorite types of LP’s.
Being Across Asset Classes
The fact that we work across asset classes is important in our pursuit of seeing differentiated deal flow. It’s easier to “know something different” than it is to know “more of the same thing everyone else is an expert on.”
Our Crypto team has sourced us stuff in the digital asset space, our Venture team has sourced us very early stage technology deals, and our Lending team has been the reason those portfolio companies have had access to capital markets in a way traditional crypto and VC funds wouldn’t be able to support.
The three funds source deals from each other, and look at each asset class through a unique lens.
Existing Entrepreneurs
Many of the best deals come from founders we’ve already invested with. It’s so important we provide a good experience to the founders we’ve backed because our reputation is, in large part, based on what they think of us. These are founders who are often at conferences, at events, or who are spending time with other fintech entrepreneurs. They know exactly what we look for, because they’ve been through our diligence process! It’s some of the best deal flow we can find.
Entrepreneurs We’ve Passed On
This is another massively important one. Across our firm, we can see up to 200 deals per month. Each time an entrepreneur pitches us, it’s an opportunity for us to market our firm.
One of the biggest wins at our firm is when an entrepreneur pitches us, we pass, and they had such a good experience anyways that they begin to send us deals.
Even when we are in meetings that after 5 minutes we know the deal isn’t a fit, it’s a chance for us to spend the next 25 minutes being helpful, and trying to leave a positive impression.
Competitors
Lending and Venture Capital have always struck us as wildly different from a culture perspective.
For example: in Venture Capital many firms like to syndicate deals. In lending, most are looking for “as much allocation as they can get.” In the event that they are trying to syndicate a deal, it’s because their fund is small, and it’s just a means to one day hogging allocation later.
Because we come from more of a venture background, we are a bit more open to syndications than other firms might be. We also try to send deals to our competitors when we know the investment opportunity doesn’t fit our credit box, but might fit theirs.
We look for very “non-traditional” investments. But if we see a factoring deal with a really strong risk-profile yielding 10%, it may be a pass for us, but a great investment for a factoring company.
The better a job we do collaborating with our competitive ecosystem, the more we start to see deals in return. This has been limited thus far, but has started to work and it’s something we are dedicated to.
Creating a Positive Experience
We can create positive experiences for the entrepreneurs we speak with any of the following ways:
- Offering advice or ideas based on similar companies we’ve backed, or seen: Often, we sound smart because we “came up with an idea.” But in reality, most companies use the same marketing hacks, underwriting tools, processes, etc. and we just apply the best ideas of our companies and (with the permission of the founder) offer them to others.
- Offering intro’s: Often, a deal might not be right for us (too small, too big, too low yielding but a great risk, etc.) and it’s not just our option, but our OBLIGATION to make an intro to someone we think could back them.
- Giving benchmark data: The lending world is often opaque. Founders might be wondering:
- What are market terms for what I’m doing?
- What should my default rate be?
- At what point in the term of the loan will most borrowers not repay?
- What should my payment curves look like?
If we can be helpful by offering guidance on data we’d like to see, or expect to see, within a loan tape or within the business, we can help offer goal posts to a company.
- Being specific about why we pass: One of our biggest pet peeves is when we hear a firm say: “Thanks, this is just too early for us.” This is often (a) not true and (b) hurts that firm’s reputation. It happens in VC a lot, where a VC thinks the idea is good but has doubts about a specific item of the business, and just says “too early” as an easy way to say “no” while still getting to look at the deal later. We work really hard to be specific about the reasons we are passing. Those reasons could range from:
- We think that the barriers to entry are low, and another competitor with cheaper capital could be difficult to beat.
- We think this is too cyclical to consumer credit, which we don’t want to take a view on
- The loans are difficult to service, and so if the originator goes out of business, it may be tough to collect repayments
- There is too much concentration risk in the portfolio
- Fraud may be tough to manage
- Etc., etc.
Making Specific Asks
The other great hack I learned a long time ago from Andy Ellwood was to make sure our asks were specific.
When we told people: “please send us great founders,” it was useless. What does a great founder mean? What does a “great company,” mean?
Instead, we started to make asks that were more narrow, like:
- “Do you know anyone who wants to start something within the company they are working at, but their boss thinks it’s too risky or too small an opportunity?”
- “Do you know anyone who just moved cities and used to be a senior executive at a tech company?”
- “Do you know of anyone between the ages of 30–34, who’s spent 4 years or more at the same place, and just switched jobs?”
In short, we started taking common traits of the types of people we liked to back, and making our asks more actionable or easier to prompt.
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In any case, the process of sourcing high quality deal flow took time. The best thing for our brand was to do a couple of high quality deals, but it’s a bit of a catch-22 since it takes deal flow to find those deals.
Once we have sourced the deals, we begin our diligence.
Click this link to go to our post on [Initial Diligence].
For the Full Series of Posts, Please See Below:
(1) Part 1: An Intro to Online Lending (LINK)
(2) Part 2: An Intro on How To Source Deals [LINK]
(3) Part 3: Initial Diligence [LINK]
(4) Part 4: Deeper Diligence [LINK]
(5) Part 5: Structuring The Deal [LINK]
(6) Part 6: Building a Credit Model [LINK]
(7) Part 7: Monitoring Your Investment [LINK]
(8) Part 8: Conclusion [LINK]
