Bill Burnham on "Deal Flow Is Dead"

Bill has a great post on  Deal Flow Is Dead, Long Live Thesis Driven Investing, in which he points out that the secular VC approach of attracting the best possible dealflow, and invest in a small subset of these opportunities, is becoming difficult for all but the best or most established firms.

The sheer size of the investment community, in terms of firms, professionals and capital, has become such that VCs have to compete on good/great deals unless they can develop a proprietary dealflow. The best firms will be able to limit the inflationary effect of this trend on valuations, with statements like "Working with us increases dramatically your chance of success and major exit", and with a handful of them - it is statistically true.

One way of developing a proprietary dealflow is to develop extremely close relationships with leading universities and laboratories, and make sure that the first call, the first show, is to firms sponsoring work or studies. One of many local examples is DFJ's sponsorship of Stanford's ETL Program.

Another is to hire entrepreneurs "in house" and get them to work on a very specific portion of the dealflow, and at the same time start developing the fundamentals of a new venture. The implementation of an EIR (Executive In Residence) program is specific to each fund, but the concept is the same: hire a talented entrepreneur in a space of interest, give him/her access to the resources of the fund (partners, contacts, portfolio,...) in order to offer the best possible environment to  the new breed, provide the seed capital, attract additional talents, and eventually launch the company. Depending on the arrangement, EIRs and the firm may or may not have a commitment of working together after the incubation phase.
Examples of EIR'ed companies are SpikeSource (Kleiner Perkins) and Scalix (Mayfield). Kleiner Perkins is actually an example of a Tier 1 firm that mentioned they had something like three or four such projects going on.

Executive recruiters have been very busy hunting for EIRs over the past few months, in noticeable  numbers. However this mode of developing is not a panacea, since it involves a market risk, and a team/product risk, risks that VCs try to mitigate by looking at multiple opportunities in a space they are interested in.

Also check out Paul's comments on this post.