This is the second post in our series about how private equity and venture capital firms can leverage their relationships to create value. For the first installment, discussing the role of relationships in portfolio operations, click here.
Private equity firms operate in an increasingly competitive environment. EY Global observes that firms face both greater in-industry competition – total assets under management have doubled between 2006 and 2017 – and increased competition from direct investors like sovereign wealth funds and family offices. 36% of respondents to a 2016 Preqin survey said that it was more challenging to find investment opportunities that year than the one previous. To retain their edge in securing quality investment opportunities, top private equity firms have invested heavily in deal origination.
The most effective private equity deal origination teams share two traits. First, they understand the market and have a strong investment thesis. Second, they build strong relationships with referral sources who advise companies for sale. Relationship capital is therefore a critical asset for deal origination professionals.
The Evolution of the Private Equity Deal Origination Team
Deal origination, also known as deal sourcing, is the process finance professionals use to identify investment opportunities. The goal of an origination team is to provide the firm’s investment professionals with a high volume of promising deal opportunities for evaluation. Gretchen Perkins, who manages investment sourcing activities for Huron Capital, summed it up: ““Our main job is to find enough quality, actionable deal flow so our firm can remain disciplined about the deals we choose to pursue.”
Just a few years ago, a private equity firm could gain an edge simply by having a dedicated deal origination team in place. Separating the sourcing function from the traditional deal team increases efficiency and enables each group to work more effectively. In 2014, venture capitalist David Teten found that firms with “large-scale sourcing teams were almost all top-quartile performers across stage, vintage, and sector.”
Now that more and more firms have built out their origination teams, however, simply having a dedicated function is not enough. Bain & Company recommends that deal sourcing groups take a two-pronged approach: (1) have a strong point of view about the type of investments the firm should make, and (2) expand their networks of “formal advisors and informal influencers” in order to be introduced to high-value targets.
A Strong Investment Thesis
A firm without a strong investment thesis risks missing out on quality opportunities. Investment bankers and others who advise firms for sale can be reluctant to introduce a firm without relevant expertise. Ramsay Goodrich of Carter Morse & Goodrich told Axial that he doesn’t “feel compelled to show folks deals just so someone can ‘check a box.’” However, “if they want to discuss a well-thought-out investment thesis…I will have that conversation with them every day.”
Bain observes that a strong thesis also provides structure to deal teams and sets them up for success. Their research shows that “deals within a firm’s sweet spot consistently and significantly outperform opportunistic deals that stray from it.”
Why Relationships Matter for Private Equity Deal Origination
Even firms who have a strong perspective on where they want to invest need a strategy for securing those investment opportunities. This is where relationships come in.
The criticality of relationships is a key theme across research into successful deal origination teams.
- Axial’s study on the rise of private equity deal origination teams observes that cold-calling is no longer a viable strategy for these groups. Instead, “building new relationships in and around the industry and tracking those relationships has become the central responsibility of deal origination teams.”
- According to Bain, “to uncover more hidden gems, PE firms will have to spend time building out their network.”
- EY observes that “PE firms are working their networks harder than ever before. While they continue leveraging their traditional relationships with bankers and industry executives to generate some deal flow, firms are now casting an even wider net.”
Firms with strong industry relationships have the edge in deal origination for two primary reasons.
First, they are top-of-mind with investment bankers, attorneys, and others who advise companies for sale. When a bank has a strong connection to a private equity firm, they will recommend that firm over a relative unknown, even if the two firms have the same level of experience and expertise. As Gretchen Perkins at Huron puts it, “To find the right deal flow, relationships mean everything…we want to be the first private equity firm that any referral source thinks of.”
Second, having good relationships with industry leaders builds a good reputation and establishes credibility. A less-connected firm, however capable, may not be as trusted.
It pays to have a wide network, not just a deep one. Bain and EY both stress the value of relationships with informal influencers who can help identify opportunities that the firm would not otherwise encounter.
RelSci for Deal Sourcing
Relationship Science is the best tool for relationship-driven business development. Private equity professionals in portfolio operations, talent acquisition, and due diligence all leverage the RelSci platform to generate value. Private equity deal origination teams can also leverage RelSci’s capabilities to build strong relationships with referral sources who advise companies for sale.
Several RelSci features are particularly relevant for private equity deal origination.
As Bain observes, “advisers, industry experts, lawyers, bankers, potential partners or targets, potential buyers, intermediaries, ex-CEOs, academics, leaders of trade organizations, and existing or past portfolio management teams” can all be useful in the deal sourcing process. RelSci’s database of over 9 million individuals is filled with these types of people. Our platform includes:
- 342,000 decision makers at investment banks
- 358,000 attorneys and senior law firm leaders
- 434,000 individuals at accounting and financial services firms
Each RelSci profile includes a dossier of background information on the individual. Profiles also illuminate shared connections who can introduce you to the person you’re trying to reach.
News and Alerts
When you’re looking to build strong professional relationships, it can be hard to identify the right opportunity to connect. You don’t just want to reach out when you need a favor. But you also want to avoid awkward, “hey, hope you’ve been well!” emails out of the blue.
RelSci 360° Alerts provide a steady stream of intelligence on your network. You’ll receive an alert when a contact makes news, receives a promotion or board appointment, or is involved in a transaction. These alerts provide the perfect excuse to send a thoughtful note that will help you build a stronger relationship over the long term.
Private equity firms leverage countless data providers to identify potential acquisitions that fit their investment thesis. RelSci isn’t a replacement for these tools. But it adds a relationship intelligence layer that helps deal sourcing teams identify and prioritize deal opportunities.
Deal origination teams can use Power Search to cross-reference prospects that meet their investment criteria with their firm’s relationships. Search fields include industry, keyword, financials, prior advisory and investor relationships, appearance on an imported prospect list, and more. Shortest path information accompanies each search result and highlights who in your network can introduce you to the deal opportunity.
RelSci’s new Similar Prospects tool allows you to import an existing prospect list and identify similar organizations you might have missed.
If you maintain a wide network, as Bain and EY advise deal origination professionals to do, it can be difficult to know where to focus. For any given business development opportunity, some people in your network will be better situated than others.
Relationship Discovery enables you to visualize your connections to a target industry, location, role, or list of companies. At a glance, you are able to see which relationships to cultivate based on who is most connected in your area of interest.
You can then explore further to see your connections to specific companies.
Private equity deal origination teams need an edge that will enable them to generate both quality and quantity of deal flow in an increasingly competitive industry. RelSci provides that edge. Our relationship capital platform enables sourcing teams to build strong reputations, stay top-of-mind with advisors, and secure new deal opportunities.
If you’d like to learn more about how RelSci can deliver value for your firm, request a demo today.