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VCs source deals both actively and passively.

Active sourcing entails identifying concepts or sectors that are of interest and then scrubbing the marketplace to identify potential investment opportunities in the relevant sector(s).

In the passive sourcing strategy, investors rely on relationships and reputation to bring investment opportunities to them. You could say that VCs that leverage a passive sourcing strategy don’t always know what they’re looking for - they’ll know it when they see it.

It’s worth noting that both of these strategies can work for investors. While most investors benefit from some passive sourcing, VCs that invest in earlier-stage companies are more likely to rely more heavily than later-stage investors on passive sourcing. There is good reason for this tendency. While sector analysis can identify early-stage investment opportunities, many great start-ups create new markets or alter industries in ways that are difficult to foresee. One must see the company to see the market opportunity in these cases.

In contrast, later stage investors are more likely to only invest in companies that have already received an investment from a VC. As a result, these investors (especially in healthy economic environments) need to be more proactive in seeking out investment opportunities in order to deploy capital. The passive sourcing strategy is also used by later-stage investors, but this strategy largely entails developing relationships with early-stage investors.

There isn’t a right or wrong sourcing strategy. Investors use both, but develop sourcing strategies informed by the stage at which they invest, along with other factors.