US private equity middle-market firms are navigating a complex environment marked by inflation, fundraising uncertainties, and stiff competition from numerous private equity funds. To maintain a competitive edge, these firms prioritize growing their deal pipeline and staying ahead of industry trends. This involves identifying and securing untapped potential investment opportunities or proprietary deals, thereby ensuring their ability to innovate and grow strategically within the industry.
Private equity deal sourcing is critical to ensuring your PE firm’s success. You can’t rely on old-fashioned techniques such as scouring the latest trade publications and cold-calling companies in crowded markets, hoping to find target companies to invest in. You need to leverage relationships to find referrals and use the latest technology and data-driven evaluation tools to create a steady pipeline of potential PE deals that fit your firm’s investment criteria.
This article will discuss modern deal-sourcing strategies for private equity firms. These strategies will help you blend new techniques and technologies with traditional methods to maintain a healthy deal flow pipeline and make the best investment decisions.
Hire an In-House Deal Origination Team
A survey of private equity firms conducted by David Teten from HOF Capital shows that the top 15% of PE firms employ a proactive deal origination strategy. The largest practitioners of origination programs – including Battery Ventures, Great Hill Partners, Insight Venture Partners, Platinum Equity, Summit Partners, TA Associates, and TCV — typically had between 0.75 and 1.25 dedicated deal sources for every generalist investment professional, according to Teten’s research.
Dedicated in-house sourcing teams play a critical role: they hunt for new opportunities using strategies that rely on relationships, market research, and technology.. Efficient deal originators or business development professionals specialize in different industry verticals to be more effective at finding potential acquisitions. Initially, these teams would rely on cold-calling companies, investment banks, and other intermediaries to source deals, a strategy that has lost effectiveness over the years. Modern origination teams use technology and data analytics to build and nurture relationships around the industry to find quality deal flow and present them to GPs, buy-side analysts, and other dealmakers in the firm.
Many industry insiders are firm believers in the power of a well-trained and focused origination team that understands the market, can source deals, and moves them down to other deal team members. This origination process frees the originators to hunt for more opportunities once they do initial outreach, and they are passed down for further evaluation and due diligence.
To succeed in today’s environment, your firm needs a dedicated team specializing in relationship-building with private companies, investment banks, family offices, venture capital firms, industry groups, etc.
To get the most value from your in-house deal origination team, they must be armed with the correct PE tech stack, including a relationship intelligence platform.
Manage Relationships at Scale
Deal Sourcing is an essential step of the deal flow process, and optimizing this stage can give your firm a competitive advantage. Optimization does not involve relying entirely on LinkedIn, algorithms, and online deal-sourcing platforms to find market trends and discover deals since these technologies will never replace the power of human relationships.
Enter the relationship intelligence CRM platform. These modern technologies like 4Degrees are designed for private market teams to build, maintain, and leverage high-quality relationships to keep your firm top of mind with finance professionals, management teams, venture capitalists, entrepreneurs and other potential deal sources.
Relationship intelligence software analyzes and assesses your team’s collective network to find the best path for a warm introduction to a company, investor, or expert. The platform also mines the web for real-time intelligence relevant to your network. It alerts you about job changes, news, investments, and other relevant insights, allowing you to build and nurture relationships. Equipped with this intelligence, your sourcing teams can find potential proprietary investments (at reasonable valuations) before other firms or banks see them.
Built by ex-investors, 4Degrees is a private equity Customer Relationship Management platform that streamlines the entire deal lifecycle from origination to close.
Identify Your Attractive Deal Signals
Many potential deals exist, but only a tiny percentage fits your firm’s investing strategy. The trick is quickly identifying the ones worth pursuing and discarding the others. This will make your deal-sourcing process faster and more efficient.
PE firms evaluate an average of 80 opportunities to make one investment. And rightfully so. If your firm is deploying millions to acquire a company, you must ensure it fits your investment thesis and market position. Efficient firms can quickly go through this process by monitoring for data points—or signals—to indicate suitability.
For example, you might look for specific industries, geographic locations, revenue on earnings reports, growth potential, or a proven management team. You might also consider companies that hire a new CFO, companies looking to divest from subsidiaries, or a startup looking for a buyout.
To successfully monitor these signals at scale, you’ll need to leverage several pieces of technology. You’ll need to monitor financial reports and datasets, scan for news stories, monitor social media (especially the accounts of high-profile journalists and influencers), and communicate with investment bankers and other sources of deal information. A CRM that integrates with various tools like CrunchBase and Pitch Book is necessary to identify the right signals and make sense of all the data.
Assign Scores to Your Opportunities
Even if a potential deal gives you the right signals, that doesn’t mean it’s ready for investment. Some are more likely or profitable than others. So it’s wise to score each deal to distinguish them from one another and prioritize them in your strategy.
How you score your deals is highly subjective, so we can’t lay out an exact plan for you. You’ll need to identify and give weights to metrics and data points relevant to your investing strategy. For instance, you might score a company highly if they are family-owned and operated, whereas another private equity firm may not care about that data point.
You’ll need to review your scoring schema carefully and be prepared to adjust manually. Context is also important here. For instance, a high number of job postings could mean the company is growing rapidly or that it is having trouble retaining talent.
Multiple analytics tools can be incorporated into PE firms' technology stacks to uncover trends, gain a deeper understanding of a particular market, and assign scores to opportunities. Read this article to learn more about the PE technology stack.
Engage Early and Act Quickly
Identify investment targets early in their life cycle, long before they are investment-ready. Engaging quickly and building relationships with the owners or management team is wise before another investment firm does. By the time a target is ready to engage, you want to be their top choice as someone who has been with them along the way. They’ll see you as an interested party who cares about their business and is concerned about long-term health and growth and not just making a quick buck.
How do you engage with early-stage deals? Advice is usually your most substantial contribution. Offer to be a mentor without any strings attached. Answer their calls and reply to their emails when they need help. Make yourself a natural resource for their problems so that when they become investment-ready, they naturally come to you first.
Develop a Strong Brand Presence
According to PitchBook, 70% of private equity firms say building a strong brand is very important. The remaining 30% say that it is at least somewhat important. Interestingly, 91% of firms believe that the need for a strong brand has increased over previous years. The need for strong, clear, and well-crafted branding is likely due to greater competition: There are more private equity firms than ever.
A strong brand makes portfolio companies and limited partners feel comfortable. It pings their trust indicators, thereby making them feel safer about investing in your firm or selling a stake in their company – especially if they hear good things from your other partners and companies.
Branding is more than just your sleek logo and website colors. Your brand is how you treat people, which means – as always – relationships are key. You and your team should continually foster positive, healthy, and value-adding relationships with your existing portfolio companies, attorneys, investment banks, competing private equity firms, and other sponsors.
Key Takeaway
If you want to find the best deals for your private equity firm, you need a modern, data-driven approach with the right technologies and processes. Building relationships and implementing the advice outlined above will enable your firm to create a steady pipeline of actionable and lucrative deals.
