Guide to Deal Sourcing for Private Equity Firms

Liquidity indicators

There are several liquidity indicators that may signal that a company wants or needs an opportunity from a PE firm. Some of them are:

• C-level employees nearing retirement
• Failure to embrace technology
• Rise of greater competition
• Industry consolidation

Data analytics

PE firms can also use data analytics to find proprietary deals and improve private equity deal flow. Relevant data allows PE firms to identify industry trends, monitor potential deals, target companies, and establish high-quality relationships.

The best data type to analyze to improve deal origination for private equity is firmographic data. It consists of data points such as company name, location, headcount, industry verticals, and more.

With this data, you can filter companies by data points and get a list of the businesses that fit into your area of interest. It makes PE deal sourcing easier and less time-consuming by generating a list of potential deals.

Brand presence

Building a solid brand presence is one of the most important aspects for PE firms. According to research, 70% of questioned 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.

For this reason, target companies may ultimately select a PE firm with a stronger brand presence.

To build a stronger brand presence, it's important to foster new and existing relationships. Some examples of PE relationships may include investment banks, attorneys, and other buyers.

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 managed to leverage around 80% of the price and acquired Hilton Hotels for around $5.5 billion. After the acquisition, Blackstone fixed some of the inefficiencies that the business was facing, 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.