target company was sold through a highly competitive auction process, our team would often not be chosen as the preferred (or highest) bidder. This means that there were years when we, as a sector team, would close no deals at all. Yes, we would still review over 100 potential deals that year and close zero. Talk about a low-energy Christmas party.
This is a rather frustrating, yet typical, fact in private equity: a lot of work goes into deal sourcing yet there is no guarantee of a successful outcome. Sometimes several years will pass from your first meeting with the management of a potential investment target to the time they are ready to consider a transaction. Sometimes the company will even go through multiple rounds of ownership until the management team is prepared to meet with you again. Sometimes the company shareholders are finally ready to accept a private equity investment, just not one from your firm! However, the stars do align at some point and, with perseverance, you can manage to get a private equity transaction to a final close.
What influences the successful outcome of sourcing and closing a private equity transaction? If you had asked me this at the beginning of my private equity career, I would have said that there was a fair degree of randomness and luck in this process. It is about being connected and about maximizing your options by doing 1,000 things to cover more ground. And being in the right place at the right time. And balancing cold-blooded investment analysis with the animal spirits of a competitive auction. Back then, I would have said serendipity deserves its fair share of credit, too.
Would I give the same answer now? Actually, I would not. I no longer think of sourcing and closing transactions as a game of chance. While the rules of probability do apply to finding good deals, I think there are steps that you can take to skew the odds in your favor. Sometimes significantly. Depending on what your competitors are doing in your sector or country of focus, you can definitely enhance your deal origination prowess by a considerable margin. I have certainly seen this in my own efforts of sourcing private equity transactions.
First, let's take a look at a broad overview of these action points and then I'll delve into each one in more detail.
Commit. Make deal origination an institutional priority and aim to create a sustainable long-term competitive advantage both for yourself as an investment professional and your firm through sourcing high-quality investments. This means dedicating time to deal sourcing throughout the year even when it seems like there is no time for it.
Organize chaos. Deal sourcing is tricky because it is an informal process that involves many variables. Decision-makers change their minds. Companies get taken over by strategic investors and cease to be private equity targets overnight. What can you do when things seem out of your control? Attack the mercurial nature of deal sourcing by turning your reactive activities into a number of intentional and predictable routines. Systematize your efforts and turn them into a framework. Focus on perfecting your deal sourcing process and do not pay excessive attention to interim outcomes. A better process will eventually lead to superior results.
Conduct deep industry research. Create a unique information advantage for yourself and your team by developing expertise in a couple of industry subsectors. Make sure you build a detailed knowledge base in these subsectors, generate your own insights and initiate a flow of proprietary deal ideas. How do you do that? I have spent many late nights leading various industry “deep dives” and have developed my own framework for tackling this exercise. I will share these tactics with you later in the book.
Prepare your firm to move quickly. Institutional agility can be a remarkable advantage, especially in a highly competitive deal environment. It is important to provide regular updates to your firm, especially your investment committee and key decision makers, on the main investment themes that you are working on. The goal is to get as much support as possible and ensure that everyone is aware of the detailed knowledge your team has acquired through deep research. One of the best ways to do this is for your team to develop and share their proprietary analysis of a sector with the rest of the firm. That way, once you identify a suitable deal in this industry, your investment committee should already be warmed up. They will trust your team to come up with a differentiated “deal angle,” giving you the ability to move forward with confidence and progress the deal ahead of your competition.
Develop an efficient deal sourcing process. Take a step back and identify the areas of your deal sourcing process where most of your time is wasted. Does it feel like you are busy creating too many options by doing 1,000 things? Are you attending too many meetings with intermediaries who miss the point of your mandate and bring deals that make no sense? Is your deal sourcing network fully optimized? Are your meeting notes well-organized, searchable, synchronized and easy to access, both in the office and remotely?
Once you have had an opportunity to reflect, try to come up with ways to streamline your deal sourcing process. Aim for the end result to resemble a clock with a precise Swiss movement. Instead of doing 1,000 things to cover more ground, reduce your efforts to the 10 most value-added activities and repeat them with precision 100 times. These numbers are arbitrary, but you get the point: abandon deal sourcing tasks that yield no result, focus on the most productive activities and pursue them in a disciplined manner. This process should free up some of your time and enhance the quality of deals under your review, both of which will boost the probability of a successful outcome.
Persist, smile, repeat. Now that you have created a proactive deal sourcing work plan, make sure there are dedicated slots reserved in your calendar to keep the process moving. Deal sourcing should be relentless and tick away with the dependability of a clock. Do not be tempted to drop out of the deal origination process, even during busy times. You can simply do less deal sourcing work during busy weeks. The only way to beat your competition is to work smarter. Take the time to put necessary reminders in your system for any follow-ups and be disciplined about following through completely. Do your best to maintain a positive spirit when deals disappoint. Take a deep breath, smile, move on and start again. Deal sourcing is simply a fixed number of efforts, persistent and repetitive, that eventually result in a big payoff.
Originating new deal ideas can sometimes feel like a mammoth task, but taking small steps can make it much more manageable. Just a few hours a week of proactive and intentional deal sourcing work can make a big difference and help you stay ahead of your competition. As the old proverb goes, “Water dripping day by day wears the hardest rock away.”
Deal Sourcing Strategies
What sourcing strategies are out there? Generally, people in our industry talk about two types of private equity deals: thematic and opportunistic. Thematic investments are potential transactions that you identify proactively through the rigorous and granular research of a particular industry subsector, emerging trend or a specific investment thesis. Thematic deal ideas sometimes do not have any obvious catalysts and can take a long time to become actionable. Opportunistic investments rely on a more passive effort on your part: they are inbound transactions that simply land on your desk. Opportunistic transactions are typically a lot more actionable: there is often a motivated seller who wants to get a deal done within a specific timeframe. The majority of opportunistic deals are introduced by sell-side intermediaries, professional connections and, less frequently, friends or acquaintances.
Based on what I have seen in the private equity market, most firms tend to pursue both types of deal sourcing approaches in order to develop a sustainable flow of new investment ideas. Thematic deal sourcing helps you narrow down your area of focus and build a knowledge base, which in turn increases the probability of finding an opportunistic deal in which your firm can position itself ahead of the competition as the most credible buyer.
The longer I worked on both thematic and opportunistic transactions, the more I thought about how to optimize the deal search process for both types of deals in order to create an effective routine. It took me many years, with many ups and downs, to outline a set of
