In the Private Equity (PE) context, deal sourcing implies the identification of new potential investments and thus describes the initial stage along the PE value chain. It constitutes one of the main tasks for Junior Investment Professionals and is an exciting way to become familiar with different business models and industry characteristics. Private Equity has established itself as an attractive asset class over the last decades. According to Bain & Company, buyout funds raised $387bn in 2021 alone, marking the second-best year ever. This high influx of dry powder is leading to increased competition for the best investments. Especially the technology sector – accounting for more than 30% of total buyout deals – is highly competitive. Accordingly, a well-structured deal sourcing approach is becoming more important. Generally, various channels can be distinguished in the deal sourcing process – in particular, M&A advisors, Proprietary Research, and a well-maintained Network. In the following, different approaches are examined in more detail from the perspective of a Private Equity Investor.
M&A advisors
M&A advisors represent a sustainable and well-established source of deal flow for PE investors globally. They accompany entrepreneurs aiming to sell a majority or a part of their stake through the entire transaction process. The procedural effort of a sales process including various due diligence streams, negotiations and contract work can often be overwhelming for the entrepreneur in addition to the day-to-day business. A specialized M&A advisor is familiar with all successive steps and technicalities of the transaction process, can pre-filter and approach potential buyers and thus acts as a sparring partner to the selling party – which often goes through such a procedure for the first time, especially in the case of bootstrapped companies. At the same time, M&A advisors maintain excellent relationships with potential buyers in their respective industry and therefore depict a crucial passive source of deal flow for PE companies.
Proprietary research
Proprietary research on the other hand, represents the active identification of suitable companies according to the predefined investment criteria. For example, FLEX Capital is actively looking for software companies and tech-enabled services in the DACH region. Based on these criteria as well as other factors such as the company size measured by parameters such as revenue, EBITDA or the number of employees and customers, companies are pre-filtered accordingly. The many different parameters in the investment thesis make a fully automated deal sourcing approach through proprietary research almost impossible. However, investment professionals are increasingly turning to a data-driven research approach. New tools and technologies make it possible to understand comprehensive data better and faster than the traditional approach of sifting through unstructured data and company profiles. The key to success lies in generating new insights from accessible data and interpreting patterns in a targeted and resource-efficient manner.
Professional and personal networks
Professional & personal networks represent another key driver in a PE fund’s deal sourcing strategy. This includes the personal network of the managing partners, but also investment professionals as well as the network of existing portfolio companies. Portfolio companies and their representatives are sometimes even better connected in their respective industry, which is a crucial anchor especially for potential add-on investments. Certainly, Private Equity is a people business and the development of an extensive network, especially in the related target industry, is an essential component for sustainable and successful deal sourcing. Continuous exchange with entrepreneurs and industry experts through events, trade fairs, exhibitions, fireside chats, or personal introductions not only expands industry know-how, but also facilitates access to potential future investment opportunities through a variety of touchpoints.
In conclusion, a structured deal sourcing approach should be part of the key repertoire of a professional investor to continuously distribute capital in the best possible way. The process helps to continuously internalize the investment thesis as it enforces quick learning and the ability to recognize patterns to find the best investment opportunities.
