Finding new deals is essential for private equity firms, venture capitalists, and investment bankers to sustain their business. While existing portfolio companies could be a source for new leads and introductions, it's not the best practice to rely solely on that.
In this article, you will learn top private equity deal-sourcing strategies, what solutions you can use to improve the deal-sourcing process, and what data is most beneficial while trying to find more deals.
What is private equity deal sourcing?
Private equity deal sourcing is the process of identifying and evaluating new companies to invest in. Often it involves mid-market companies, startups, or mature businesses undergoing restructuring. These companies typically operate in high-growth industries or sectors with strong market potential. However, the process is different between private equity funds and venture capital.
Private equity firms invest in private companies that aren't on the public stock exchange list, making it harder to find new opportunities. Conversely, venture capitalists mostly invest in public startups that show signs of growth. They might look for stealth startups, too, but most opportunities occur within the publicly available area of startups.
In private equity deal sourcing, a firm analyzes 80 investment opportunities on average before making 1 investment.
Why is deal sourcing crucial for private equity success?
An effective deal sourcing strategy ensures that private equity firms secure high-potential investment opportunities ahead of competitors, enabling them to achieve strong returns for investors. It’s the foundation for building a diversified portfolio and sustaining long-term profitability.
Different types of private equity deals
1. Buyouts
A common type of deal where private equity firms acquire a controlling stake in a company. These deals often focus on mature businesses that can benefit from operational improvements or strategic repositioning.
Deal prospects Companies with stable cash flow but operational inefficiencies or underperforming management.
2. Growth Equity
These deals involve minority investments in high-growth companies that need capital to scale operations, expand into new markets, or launch new products. Growth equity focuses on businesses with proven revenue models.
Deal prospects: Companies experiencing rapid revenue growth but constrained by limited capital for expansion.
3. Venture Capital
Private equity firms invest in early-stage startups with high growth potential. While these investments carry higher risks, they also offer the potential for significant returns.
Deal prospects: Startups with innovative products/services, a scalable business model, and strong leadership teams.
4. Distressed Investments
Investing in companies experiencing financial difficulties or operational challenges. The goal is to turn the company around and realize returns through restructuring or eventual sale.
Deal prospects: Companies with declining financial performance but valuable assets or market positioning.
5. Secondary Investments
Buying stakes in private equity funds or acquiring positions from other investors. Secondary deals provide liquidity to existing investors and allow firms to invest in established assets.
Deal prospects: Funds or companies with proven track records seeking to divest mature positions.
Top strategies for private equity deal sourcing
Private equity deal sourcing requires a blend of strategic initiatives, data-driven insights, and relationship management. Below are the key strategies to enhance deal origination processes:
1. Proactive Deal Origination
- Directly reach out to target companies identified through market research and firmographic data.
- Focus on underserved markets and sectors with high growth potential.
- Use predictive analytics to identify companies likely to seek investments.
2. Growth Monitoring
Monitor growth signals such as headcount expansion, revenue trends, and market presence:
- Identify companies scaling rapidly or with potential to consolidate fragmented markets.
- Use datasets combining employee data, startup data, and financial metrics for targeted monitoring.
3. Leveraging Relationships
- Build trusted partnerships with advisors, brokers, and industry leaders.
- Engage consistently at industry events and conferences.
- Establish long-term connections with key decision-makers in your sectors of interest.
4. Liquidity Indicators
Recognize signs of companies ready for investment or partnerships:
- Leadership transitions or C-suite executives nearing retirement.
- Struggles with technology adoption or increased competitive pressures.
- Industries undergoing significant consolidation.
5. Data Analytics
Use analytics to refine deal pipelines and identify promising opportunities:
- Leverage firmographic data for filtering high-potential sectors and companies.
- Monitor emerging trends with advanced tools like AI-driven platforms.
- Automate repetitive sourcing tasks to streamline deal origination.
6. Building a Strong Brand Presence
Building a solid brand presence is one of the most important aspects for PE firms. According to research, 70% of private equity firms declared that brand-building was very important.
One of the main reasons behind this increase in brand-building rises from competition for the best deals. Deal sources are not exactly limitless; therefore, investors face fierce competition while trying to generate leads:
- Publish thought leadership content to establish credibility.
- Maintain a strong digital presence on LinkedIn and other professional platforms.
- Build a reputation for successful deals and collaboration to attract more opportunities.
These strategies, when combined, provide a robust framework for private equity deal sourcing, ensuring a steady flow of high-quality opportunities.
Tools and Platforms for Deal Sourcing
Deal Sourcing Software
Platforms like DealCloud or Affinity simplify deal tracking and relationship management. These tools help firms organize their pipelines and track interactions with potential targets.
Data Providers
Access to high-quality private equity deals database is critical for informed decision-making. Providers like Coresignal offer rich datasets on private and public companies, enabling firms to analyze:
- Financial health.
- Industry trends.
- Executive profiles and employee changes.
CRM Systems
Customer Relationship Management (CRM) systems like Salesforce ensure firms can efficiently manage and nurture their relationships with key stakeholders, ensuring no opportunity is overlooked.
Private equity deal structure
In this section, we will briefly discuss the private equity deal stages. The deal pipeline in private equity consists of 12 parts:
- Sourcing. The first step is deal sourcing. Dedicated business development professionals can streamline the process by building lists from research, emails, calls, and other sources.
- Signing an NDA. Once the investment firm has gained interest in a company, they will move on to signing a Non-Disclosure Agreement (NDA) and then finance professionals can assess and examine the company's records before proceeding.
- Initial due diligence. Due diligence helps understand the company of interest better and see a fuller picture. Deal teams are usually the ones performing this type of due diligence.
- Investment proposal. After successful due diligence, the investors proceed to propose an investment and submit it to the investment committee of the company.
- Non-Binding Letter of Intent (LOI). In this stage, the investment team provides the target business with a non-binding LOI for the transaction of funds. The amount is usually defined in a range, not a specific value. After that, the target company selects several bids and proceeds to the next round of auction.
- Further due diligence. Similar to the initial due diligence. Only now, the target company brings forth more confidential information about their business.
- Building an Internal Operating Model. In short, this stage includes a meticulous breakdown of detailed revenue and cost information.
- Preliminary Investment Memorandum. This stage is about presenting a summarized document to the private equity firm's investors that includes a company overview, executive summary, market overviews, valuation overviews, risks, exit details, and more.
- Final due diligence. During this stage, the private equity firm conducts all the due diligence that hasn't been done before for a complete and final evaluation.
- Final Investment Memorandum. Once the investment committee gives its final approval, they create a Final Investment Memorandum and the deal team proposes a specific amount of valuation for the acquisition of the company.
- Final Binding Bid. The Final Binding Bid is the final price offering to acquire the target company.
- Deal signing. The final stage is when the seller selects a winning bid and signs the documents with the PE firm.
These 12 stages are the key elements of the private equity deal process.
Private equity investment cycle
The investment cycle is the period of time during which the target company is being managed by a private equity firm. The cycle breaks down into three stages: the fundraising, investment, and harvest periods.
The cycle for most firms dealing with private equity averages around 7-10 years.
Private equity deal example
Blackstone, which started out as a Mergers & Acquisitions advisory firm, used a leveraged buyout to acquire Hilton Hotels. The total worth of Hilton Hotels stood at around $26 billion in 2007.
Blackstone leveraged around 80% of the price and acquired Hilton Hotels for around $5.5 billion. After the acquisition, Blackstone fixed some of the business's inefficiencies, sold assets that weren't performing very well, and switched to better locations.
After 11 years, Blackstone sold Hilton Hotels at a ~$14 billion profit.
Some top PE firms that use proactive deal sourcing
David Teten, a managing partner with HOF Capital conducted a survey that shows that the top 15% of private equity firms, such as Battery Ventures, Insight Venture Partners, Great Hill Partners, Platinum Equity, TA Associates, Summit Partners, and other firms used a proactive deal sourcing process.
According to the research, these firms usually had between 0.75 and 1.25 deal sources for a single generalist investment professional.
Summary
All in all, while private equity deal sourcing might not be the easiest step of the entire process, it's essential to sustaining the business.
PE firms have to sift through a large volume of leads before they find a potential investment opportunity. However, as we can see from the example above, it could be quite profitable if done successfully.
Frequently asked questions
