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Advisors, Family Offices, Private Equity

The Rise of the Deal Origination Team

Over the years the data has shown that private equity shops with large, proactive, outbound origination programs are also top-quartile performers. For example, in 2014, David Teten, a managing partner with venture capital firm HOF Capital, found that investors with dedicated, large-scale sourcing teams were almost all top-quartile performers across stage, vintage, and sector. The largest practitioners of origination programs – including Battery Ventures, Great Hill Partners, Insight Venture Partners, Platinum Equity, Summit Partners, TA Associates, and TCV — typically had between 0.75 and 1.25 dedicated deal sources for every generalist investment professional, according to Teten’s research.

Today the majority of private equity firms have some sort of organized deal origination strategy. And while it still may be true that firms with dedicated origination teams have top quartile returns, it’s become harder to quantify the success because just about every private equity firm has some type of deal sourcing program in place, but strategies vary greatly. For example, some firms still cold call companies, while others employ numerous business development professionals to call on banks and businesses.

Despite all the different methods of outreach, some private equity firms have not perfected their strategy. Ramsey Goodrich, a managing partner with Carter Morse & Goodrich, a Southport, Connecticut-based investment bank, says although most private equity firms have made a concerted effort to grow their deal sourcing capabilities, many are not marketing themselves effectively. “I get at least 20 emails every day from private equity funds asking me to show them every deal. Most say they are industry agnostic, but looking for a well-run company in a defensible market, with strong margins, good growth, and a management team that wants to stay. There is not much in that pitch that makes them stand out from the crowd,” he says.

Trying to see every deal a bank has is a common strategy for some deal origination teams, but not well received by investment bankers. “I don’t feel compelled to show folks deals just so someone can ‘check a box’ that we showed them a deal, especially if it’s not relevant. However, if they want to discuss a well-thought-out investment thesis or a specific portfolio company that is looking for an add-on, I will have that conversation with them every day and will proactively find deals for them,” says Goodrich.

The best deal origination professionals truly understand the market. “We put together our buyer list by looking at many sources like CapitalIQ, Axial, and Pitchbook to make sure they have a portfolio company that is active in the space. If they don’t already know a lot about the niche in which we are working, I don’t want to have to educate them on all the dynamics of an industry, especially if they most likely will not get there in the end.  I really want to find the right people who get it so not to waste their time — or mine,” says Goodrich.

Tiff Armstrong, a managing director with Harris Williams, says depending on a private equity firm’s strategy some deal origination teams can be more helpful than others for investment banks. “Private equity is getting more and more specialized in industry verticals. Often, the buyers have to be an expert in an industry vertical, and some deal origination sources are more generalist. Specialization is prevalent,” says Armstrong. “We always keep the business development team looped in, but we also need to talk with the private equity professional who knows the language of the industry vertical – for example if it’s a healthcare, consumer, EPI or a tech deal. Knowing who has the industry knowledge and what private equity partner is making the decision is really critical. In the lower middle market where industry verticals are perhaps less developed, generalist origination efforts are likely more effective. The origination teams also help make sure no balls are dropped, that the Is are dotted and the Ts are crossed.”

While it’s clear that some firms are struggling to use deal originators correctly, there’s still no question that a strong deal origination team can make all the difference in today’s hyper-competitive market. However, it’s important to note, the job has become much more complex. When TA Associates and Summit were some of the first to launched origination programs decades ago, cold-calling was the core strategy. Young professionals called companies to hopefully get a foot in the door before these companies were ready to consider a transaction.

Building new relationships in and around the industry and tracking those relationships has become the central responsibility of deal origination teams. The challenge today is that there are so many more groups to know. According to Boston Consulting Group, as of January 2018, there are a record number of private equity firms in the market with more than 2,700 seeking to raised funds. “Deal originators have to keep tabs on companies, fundless sponsors, family offices, investment banks, and other sponsors,” says Amy Weisman, director of business development with Sterling Investment Partners.  “It’s much harder to identify these groups without dedicated people. And most firms also require business development teams to track the interactions using customer relationship management systems, which adds time to the job.”

In addition to all the new groups origination teams have to keep track of, there are also more technology platforms like Axial that deal origination teams are also keeping their eyes on, says Weisman.

With all of the various sources of deal flow, the trick for deal origination teams is to be able to find the right deal flow for their respective firms. “Our main job is to find enough quality, actionable deal flow so our firm can remain disciplined about the deals we choose to pursue,” says Gretchen Perkins, a partner with Huron Capital. “On the whole, it’s much more efficient to have an origination team sifting through what’s out there, rather than allowing the deal teams to do the prospecting while they are also doing the heavy lifting of achieving strategic objectives in the portfolio companies as we seek to build shareholder value. They don’t have the bandwidth to be effective in both areas.”

Perkins says that Huron sees upwards of 100 companies going to market each year that are great targets, but the firm declines to pursue them because they are part of a broad auction process. “That’s not a good place for us to spend our time. There will be someone who will pay more because they need to get a deal done or are will to underwrite to lower returns because they had to pay a premium market price. We are actively choosing our spots and what we want to pursue,” says Perkins.

To find the right deal flow, relationships mean everything and that’s why meeting to as many of the right sources as possible is so important. “We want to be the first private equity firm that any referral source thinks of when they are advising a company for sale,” says Perkins, adding that that means having relationships with accountants, wealth management advisors, and attorneys in addition to the usual suspects. “These are sources that business owners often trust and talk to when they are considering a sale. We want them to be thinking of us. We want the referral sources and the target company to know us, trust us and like us already,” says Perkins.

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