Deal Origination: Difficulties in Private Equity Deal Sourcing & How to Improve

Those in the financial sector who work at buying, selling and investing in private equity at various stages of companies will all tell you the same thing when it comes to the difficulty in their jobs: deal origination and deal sourcing is perhaps the most difficult aspect of their jobs.

M&A advisors are always looking for that perfect company to sell while the buy-side folks are intent on doing the same thing, only to enhance their proprietary deal flow.

All firms have the same difficulty. They’re all looking to effectively scale the number and quality of deals that flow in and out of their practices each year. This is true regardless of firm size. Everyone is looking for new deals and better flow.

Buy-Side Deal Origination Difficulties

The struggle on the buy-side is that it’s a real seller’s market right now.

There is too much capital chasing too few deals that being the only one to the trough when an opportunity hits, let alone the first to the trough, doesn’t matter today. We’re seeing more M&A auctions–even among financial buyers. With the supply/demand economics of most deal opportunities completely out-of-whack, it makes it difficult to find the good deals that don’t already have at least three other interested players. This bodes well for sellers and their intermediaries, but provides complete annoyance for the private equity groups and family offices looking for a good place to put their financial capital.

Sell-Side Deal Origination Difficulties

The sell-side can often be just as fierce, but for different reasons.

The potentiality of all the baby boomers retiring has bolstered the market for sell-side investment bankers and M&A advisory firms all competing on the same turf, for the same deals. Increasing the supply does have the effect of decreasing the costs inherent in transactions and M&A fees, but

One thing is for certain, the only constant in life and in business is change. And the sands are changing quickly, especially when it comes to how both buy and sell-side opportunities are sourced and deals are done. This is true from both a deal origination standpoint and a deal structuring standpoint. Here are some ways operators in the mid-market may be using technology and media to network themselves into the next generation’s deals:

  • Online and social media. Search will continue to play a much bigger role in how deals are sourced, massaged and closed. We have a partner firm here in the Pacific Northwest who just closed a $5M EBITDA firm from a warm lead they obtained through the company’s website. Linkedin will also play a key roll in both buy and sell-side deal origination and deal sourcing opportunities. It’s true that larger organizations benefit greatly from enhanced scale, but smaller companies can use advanced media for creating a very powerful network effect without requiring a large number of warm bodies.
  • Crowdfunding and crowd sourcing. While there has been a great deal of hype about crowd funding and the JOBS Act (including JOBS Act 2.0), the dust really hasn’t settled in terms of all the regulation and operation of equity-based crowd funding, at least not yet. Whether you think it’s a good idea or not, it will certainly have an impact on the way businesses are bought and sold in the private market. In fact, it could turn traditional finance on its head as capital is democratized further. The verdict is still out, but my guess is that deal origination will become easier, but a whole host of other issues will be introduced which will cause a complete re-think of how we do things.
  • Outsourcing and off-shoring. While both have negative connotations, scale at an affordable cost is often gleaned through using outsourced and offshored labor. While the financial services sector may be difficult to truly engage because of the complex nature of transactions, the one-on-one needed support, it doesn’t meant that warm leads can’t be had through such channels and that deals can be sourced this way. Getting the deal done properly is a different story, but automation on the front-end for the sourcing will eventually be easily outsourced with things like pitchbook design, Avatar dialing systems combined with advanced CRMs and marketing automation.

While noting beats your personal network and the “who you know” approach, the winds are certainly changing when it comes to overcoming the difficulty in sourcing deals and opportunities on both the buy and sell-side of the deal. What are some other ways M&A deal sourcing is changing the way we operate in the world of finance?

Why You Should Change Your Deal Origination Strategy

It can be difficult to adapt when traditional methods seem in a constant state of flux. Waiting for the dust to settle before shifting resources is a recipe for failure. Effective methods for sourcing the best business opportunities with top talent have shifted over the last decade–and they will continue to do so. Deal originators should be aware of the shifting tide or competitors will arrive first.

Sourcing opportunities in the financial world is often the bottleneck of revenue. It’s one of the more time-consuming, but necessary tasks used for keeping a full pipeline. Even the most well-connected rainmaker still needs to keep a warm network so as to remain top-of-mind when the next big opportunity crops.

The Changing Landscape of Deal Origination

Marketing has undergone drastic changes in the last decade and the metamorphosis is still marching on. Much of the change has greatly benefited the green horn startups that often lack the financing necessary to really move the needle. Shoestring budgets are now en vogue.

Performing deal origination in the 21st century will be very different than it was ten years ago, regardless of whether you’re funding startups or sourcing elephant M&A deals.

Before you go decimating your outside sales team in favor for some social media alternative, might I suggest true “origination” is still sourced from direct contacts and partnerships. While each opportunity requires a personal touch, the original opportunity source–at least in the 21st century–is likely to arise from a much more varied group of activities. In short, true deal origination in today’s day requires a much broader net given the bifurcated nature of today’s networking world– a feat that is more difficult to manage, but ultimately doable given the tools available.

The Death of “Smile and Dial”

No, no, no “smile and dial” deal origination is not dead. One of our partner affiliates operates a call center with a half a dozen agents. They’re not in the United States. They’re in the Philippines. Their English is fantastic and their understanding of the nomenclature and nuances of the industry are superb. They’re also well educated. And, as one might imagine, they’re significantly cheaper than their U.S.-based counterparts.

There will always be a place for good, quality push marketing and networking, but fortunately today’s tools for reaching your next viable business partner or growth opportunity are much more scalable and immediately accessible.

I like some of the non-intrusive methods for keeping on top of some of the closest contacts within your network. SlyBroadcast is one such tool that allows for pre-recorded voice messages left on the phone numbers of your choosing. Make sure those your’e sending know you, otherwise the FCC may come calling. It’s only non-intrusive if the individual wouldn’t be surprised to receive a follow-up message from you.

In short, nothing takes the place of a direct discussion, especially if it’s face-to-face. In the end, business is personal.

How Private Equity Investors are Becoming More Savvy in Deal Sourcing

Sourcing investment opportunities can be a difficult task, especially in a world awash in capital and competition. Deal sourcing and deal origination are necessary skills for private equity (PE) firms that want to close more deals and differentiate themselves. The PE sourcing process is very comprehensive and exhaustive. Firms typically evaluate about a thousand opportunities every year, through different channels, including, detailed research, internal analysis and cold calling. But PE firms typically only close on a handful of deals each year.

According to Merger Market, the number of private equity firms has nearly doubled over the last decade, and US private equity transactions have dropped steadily, from about $63.4B in 2002 to about 33.2 in 2015. Some leading PE firms, like Frontenac, based in Chicago,  and The Riverside Company, a middle market firm, have reported revenue growth while other firms like the Aberdare II Annex Fund,  that primarily focus on technology companies, have had double-digit declining revenue.

What practices are the leading firms adopting and what are the reason for some to fall behind?
Let’s have a look;

The case for creating opportunities, not waiting for them

David Teten, a specialist in best practices for investors, says that investment professionals in his data set now focus more on organization and marketing. Though firms are better positioned to decide what approach better suits them, one of the main reasons that deals do not progress is a significant valuation gap between the seller and the firm. It is important to start with understanding the differing valuation methodologies and get an idea of where there is likely to be a gap. Many deals also don’t close because of low IRR and unattractive exit opportunities.

Typically, after tens of daunting cold calls or other marketing initiatives, an analyst finally has a continuing discussion with a potential target. ‘Creating opportunities,’ we mean that analysts have to start with the right fundamentals with potential targets. Many companies now focus on creating a comprehensive and structured methodology for the filtering and selection process.

Successful partners seek out expertise before making any commitments. In 83% of successful deals, the initial step was to secure exceptional knowledge from insights by the board and upper management. Also, in most successful transactions, partners spend more time in the early stages and half of their time in the company during the first three months. Lower performing, or successful deals, only got about 20% of the total time, in the initial stages. The idea here is to develop a strategic approach from scratch.

Broad industry knowledge also leads to sourcing success. Roark Capital, an Atlanta-based equity firm, depends on extensive industry insights to source many of its acquisitions.

Build a specialized Outbound Origination Program; move away from traditional means

PE firms that adopt a proactive origination strategy have had greater returns, driven by higher quantity and more investment opportunities. Summit Partners and TA Associates have advanced their originating programs to later stage buyouts. Many other firms, like The Riverside Company, have a dedicated origination group that specifically focuses on looking for attractive opportunities, in particular, sectors. Riverside also focuses on smaller deals in the lower middle-market. These firms have also developed a broad network of 24 senior, well-focused originators to produce top quartile results. They typically use market mapping to identify top sectors and use deal signals to find attractive investments.

Firms are now moving from away from the ‘traditionally broad strategic initiatives’ to narrowly focused ones where they pick a few growing industries and later developing expertise in buying assets in those industries.The use of an origination approach has allowed some firms to proactively co-create companies or opportunities. Many businesses, like Frontenac, use a “CEO1ST” strategy where they “partner with deal executives” to source their investments around “executive focused” industries.

Research by ICAEW reveals that the Aberdare II Annex Fund lacks a good origination strategy, and as a result, most of its portfolios have underperformed with an average IRR of -23.8%.

Online databases, like industryPro, provide pre-arranged fee agreements with over 25 reputable private equity funds to support their deal sourcing needs. Many funds trust these databases to provide them quality investment opportunities in their target industries. These databases are a good start for firms looking to take strategic initiatives, in particular, sectors.

Join those on Social Media

About 15% of the 1,000 venture capitalists’ blog, according to Jeff Bussgang, General Partner at Flybridge Capital Partners. Investment professionals continue to incorporate social media into their overall strategy because they find that openly discussing their investment theses gives them confidence and trustworthiness in their initiative. Though the use of social media has been growing steadily, some have been more aggressive. For example, Health Point Capital, a $750M fund, has turned their blog into a comprehensive source for M&A information in the musculoskeletal sector.

Many investors use Facebook, LinkedIn, and other informal means to stay in touch with professionals within their network. This can have positive business impacts as well.

Advanced Management Systems

Equity Touch surveyed 61 private equity firms in 2009 and found that only 22 of them had a formal CRM system. Most were using traditional means, like Excel and Outlook to organize clientele information and analytical data.  Most funds have reported that plan for a formal CRM system, often brings up political opposition but understand that the system could be valuable. Private equity firms need CRM systems that are easy to adapt to and customized to their needs. and some other companies do have some sophisticated CRM systems for private equity firms, but those are often over engineered with extensive functionality. Mckinsey showed results of a survey, in its quarterly article, which revealed companies with CRM systems are better equipped to manage their data and prioritize strategic aspects, which allows them to close more deals.

Most successful transactions are executed with performance management systems which ensure that individuals are performing as expected and the overall performance remains on track.

We can infer that leading private equity firms are adopting a focused approach through outbound origination programs, creating opportunities through targeted strategic initiatives, and specializing, in particular, sectors rather than taking a broad, undefined approach. A shift to management systems is facilitating the overall sourcing process helping to close more deals. Moreover, finally, leveraging with social media is allowing individual analysts to collaborate with industry professionals in their network, get new ideas and enhance their confidence to perform better.

Scaling Deal Origination & Deal Sourcing

Perhaps the most difficult aspect of deal origination is attempting to increase quality and quantity at the same time. It’s not possible. While Mr. Buffet keeps the riff-raff out of most of his stock by never undergoing stock splits, the rest of us must continue to kiss frogs. It’s not necessarily a quantity over quality mindset, but at some point the best deals don’t come around until you’ve reached scale. Scale in deal origination usually means scale in your contacts and a highly-effective CRM system, including detailed information about each of your contacts.

Our team uses X2Engine. Like SalesForce, it’s feature-rich. Unlike SalesForce, it’s free and open and with Amazon’s free 5GB, we’ve still not even come close to maxing-out the capacity (that after we’ve grown our business contact list to over 1,000,000).

Your deal-sourcing will only be as good as your data. Constant massaging and pinging old contacts helps you to keep track of folks as they may move and change career paths.

Getting to complete scale with your deal-flow ultimately requires casting a very broad net. It’s a holistic approach, combining all aspects of marketing–both the old and the new. Today’s net is just much more diverse and dynamic than that of yesteryear.


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Nate Nead
Nate Nead
Nate Nead is a private equity investor and the Managing Principal at Investnet, LLC. Nate works with middle-market companies looking to acquire, sell or divest business assets.