Sourcing PE deals - where to start?

I'm a banker and want to move to PE (surprise, surprise). I decided that I would try and build an investment case on my own to have something tangible to show during an interview.

So the question is this: where do I start? How does PE normally source deals? Is there any good read about this? Are there any tools out there? Who should I speak to?

Any starting point suggestions would be much appreciated! Thanks!!

 

Call anyone you know or alumni in PE right now. Get a conversation going and ask them how they think about sourcing deals and what their personal strategy is - focus on people higher in seniority as analysts and associates most likely aren't the ones sourcing targets and ideas.

I know from reading around WSO that some scour the news to see what is happening with certain companies (i.e. potential downturn or missed earnings on consistent basis), get interested, and do a little preliminary research to see if there is anything there worth looking at in detail. If sourcing were as quick and easy as going to a database or following a set of guidelines specified by a book, those in PE wouldn't be making as much as they do.

 
Best Response

Sourcing deals is one of the least science and most art part of PE. First and just to get it out of the way, the larger deals in the megafund's and larger MM shop's realm are all going to be represented by an IB. If you somehow approach a public company and get people convinced to sell to your PE firm, they are going to hire a banker, probably auction the deal and odds are that you probably won't win it. So for larger deals, sourcing is done through relationships with IB's. If you maintain good relationships with bankers, show that you're going to do what you say you're going to do and are generally pleasant to do a deal with, you'll get first looks, maybe an off market deal or a spinoff.

Even most MM and smaller deals are rep'd by an IB, boutique M&A firm, business broker (when it gets much smaller), the aformentioned PE deal sourcing shops (newer phenomenon), or maybe even an accountant or lawyer. The above things (do what you say you're going to do, don't be a dick, etc) also count for this level, and even more so because there's a better chance that you have those relationships because you're not a dick, more so than that they'll talk to you simply because you work for KKR and GS is calling on you. You just have to maintain these relationships and establish new ones all the time. That means staying in touch via email and phone calls and meeting up with these types of people for a meal, drinks, whatever. And attending the industry conferences (ACG is a good one for lower MM to MM deals). I think it's good to develop relationships with accountants and lawyers because they can be good sources for off market deals because some lawyers are smarter than everyone else and if they have a client that may want to sell their private company, they don't need a banker to get them the best price, they can do it themselves. Overly confident lawyers can be your best friends.

You can also go the cold calling route. You can use internal databases or things like CapIQ and just dial for dollars. I'd say this is the lowest conversion ratio because most companies worth buying are called on constantly by PE or IB's. I know a few guys who own private companies and they say they get a few calls/week from someone asking them if they want to sell. But if you hit one, it can be great way to land an offmarket deal, which are usually the best.

I'd also say that you can source deals in the strangest ways sometimes. You just need to put yourself out there and run in the right circles. I know that sometimes people think it's silly and a waste of money to live in the more expensive areas, belong to a good country or city club, send your kids to private school and other things that cost more than necessary, but when you run in those circles you come across people who may own a business that they may want to sell (or have friends who do), or talk to attorneys and other advisors not by cold calling on them or meeting them at industry events, but at the parents night of your kids school. It's a much better way to meet people like this.

You can also develop an investment thesis and try to find a company, companies or assets to roll up into larger play. Just say, for instance, that in 06 you foresaw the rise in domestic oil and gas production through fracking and the rest. At the time you could have bought up a bunch of leases or mineral rights or found a few oil field services companies, bought them, put the right management and capital structure in place and absolutely cleaned up if you had exited them >6 months ago.

Those are a few ways off the top of my head and by no means exhaustive. I'd be interested in hearing others. OP, are you trying to bring a deal to a PE firm as a way of getting in?

 
Dingdong08:
You can also develop an investment thesis and try to find a company, companies or assets to roll up into larger play. Just say, for instance, that in 06 you foresaw the rise in domestic oil and gas production through fracking and the rest. At the time you could have bought up a bunch of leases or mineral rights or found a few oil field services companies, bought them, put the right management and capital structure in place and absolutely cleaned up if you had exited them >6 months ago.

Those are a few ways off the top of my head and by no means exhaustive. I'd be interested in hearing others. OP, are you trying to bring a deal to a PE firm as a way of getting in?

One of my favorites, and this is probably not relevant or significant here, but Nathan Tinkler's first acquisition. The guy became one of the richest people in Australia, but his first deal is a nice case study. Given that this thread is about sourcing, I can't say for sure how he sourced it: "The seller, Canada's Sennen Resources, was much less confident of finding lots of high-grade coal than was Tinkler. “It is between two world-class assets owned by Anglo [American] and by BHP [Billiton], so I ­didn't think you needed to be a genius to work it out,” he says." He sold his little electrical contracting business and his house, raised a couple million equity through a boutique bank in order to close, later raised tens of millions more from HK to pour into the project, and finally a few yrs later sold his stake for $184m in stock, which later doubled. He was basically a fat redneck, and he was 30 when he put that first deal together.
 
Dingdong08:

Those are a few ways off the top of my head and by no means exhaustive. I'd be interested in hearing others. OP, are you trying to bring a deal to a PE firm as a way of getting in?

Firstly - thanks a lot, this is exhaustive and very interesting - I didn't even know about business brokers before.

In response to your question - yes I want to craft a thesis and sell my "investor thinking" to funds. I thought this would help me stand out. Am I missing anything?

 

This was a nice little blurb the other day: https://www.pehub.com/2014/12/are-sponsors-getting-worse-at-deal-sourci…

In short, if you are an institutional PE firm you have a bizdev team that stays in front of the now zillion intermediaries that exist in whatever market you play in.

If you are a onesie-twosie kind of guy, the answer is you never know where your next deal is coming from! I aim to do one off-market deal every 9-18 months and by virtue of hanging my shingle and telling literally every person I come across that I'm looking to do deals, I occasionally see prop opportunities from the strangest places.

If you are just doing this for an interview, I would suggest finding xyz pubco that would be a fit for the PE shop's strategy, and prepare a pitch at a 20% - 30% premium to mkt. The probability of you sourcing an actionable proprietary deal approximates 0%.

 

Good article, I hadn't seen it.

When I got into this things >a dozen years ago it was pretty unheard of to have a biz dev guy, especially in the MM. The intermediaries were pretty much IB's and a few boutique M&A guys and you could keep track of them. Now there seems to be a piece of every small to mid sized consulting firm, specialty PE sourcing firms, and a proliferation of guys who really cater exclusively to PE. It sucks because it used to be easier to come across off market prop deals. Now it's just really tough.

 

It's definitely gotten harder but the good news is that the underwriting case in the MM and lower MM is still a 20% - 25% IRR which is unlikely to change (because it's basically levered fair value), which all means that there is still a lot of wealth creation inherent even in intermediated deals!

There is also a study out there somewhere which indicates that off-market deals don't actually outperform shopped deals as they are often off-market because the buyer offered a compelling valuation. my focus tends to be on (i) really difficult deals or (ii) companies with a bit of hair on them, as those are less competitive and if you're smart and willing to jump through some hoops, you can get great value

 

Thanks for the reply. May I ask why are my chances near 0? I mean people do it and I just don't understand how I am worse. Or does sitting in a PE office as opposed to a bedroom make a big difference? This is not a rhetorical question btw.

 

Pretty similar acquisition strategies. I like hair and difficulty, maybe not bk difficulty because that's just a pain in the ass when you throw a court and a bunch of creditors into a deal, but things that scare other people and really just take a little know how to fix or structure. I really like private and closely held companies because you can find ones with some great functions such as good products and distribution, services that their customers love, good sales pipelines and a ton of other bonuses but that just have the stank that closely held companies often like fucked up acct/fin systems and controls and capital structures, a haphazard leader who while may be a great customer facing person just changes his mind too often about the overall direction of the company, poor operational controls, etc, but problems that are all pretty easily fixed if you know how. They're still all over and they tend to scare off a lot of other more "institutional" guys that just want to buy, leverage, sit on the Board and sell in 3-7 years.

 

From a perspective of an PE analyst whose main job is sourcing:

LNKD is a phenomenal tool for finding companies. If you benchmark the # of employees to revenues, you may have a sense of the scale of a company. Remember this is just a soft benchmark. If you noticed that there are 20-30 more employees in a 6 month to 1 year period, company is likely growing in scale (and may have raised $ recently).

Other tools (some you need to pay for but trust me, if your fund values sourcing it will pay for them)

  • Crunchbase for funding info
  • independent research (Gartner, Forrester, etc.)
  • private company databases
  • conference lists
  • trade blogs/websites

most important thing for sourcing: being persistent and constantly grinding. You need to understand that you can talk to over 1000 companies that may never do a deal with your fund. You need to be excited in speaking with many different CEOs and learning about their companies and markets. You need to appreciate the fact you can (and not everyone can do this) get information out of these CEOs who are 2-3x more accomplished than you.

One more tip: source many companies within a specific space/market. Your understanding of the market will make you much more credible when you talk to that 10th company.

Hope that helps

 

http://acbj.com/

subscribe to the journals in your footprint, by paper ideally (more info than online version). they will list companies that don't get a lot of air time ranked by various things: revenue for the year, patents, employees, etc. they will also list corporate filings like new business permits, commercial transactions, and so on. additionally, there will be updates on events and companies that wouldn't get national news or even be picked up by the AP.

I'd imagine finding PE deals is a lot like being a PWM guy, you have to have your finger on the pulse of whatever industry you're talking about and that comes from a lot of reading but mostly a lot of shmoozing, relationship building, networking, and so on. I could be way off base, but it sounds similar based on what some of the PE guys are saying.

one of my buddies is an analyst in charge of sourcing for a couple of industries, and his firm goes to industry conferences because they're a very small shop, but he usually gets face time at the conference because he's going as an investor, people want to meet with him and he can get a lot of idea sourcing done in short order. find out what the national associations of your target industries are like, see if you can attend as an investor, and go for it.

 

Some tips for on the call (which will be for the most part 30 minutes). Ask about:

  • Product/service use case: what does it do? is it a vertical/horizontal solution? used everyday? what is differentiated?
  • Customer: How many customers? how many lost, added? how many decisions within the specific market and how many did you see, win, lose? Who exactly do you sell into?
  • Competition: Who do you compete with? who gives you the most headaches? - Note this is a great way to find and source companies within the same market
  • Pricing model: transaction? subscription based? rev share? If services, project fee? re-ocrruing/subscription based? time and materials?
  • Go to market- Direct/indirect? channel partner?
  • Financials: Revenue? Margins? how much recurring? growth from the year before? customer renewals?
  • Growth plans: Funding plans? if yes, for what? growth vs. profit?

Understand in a short call you won't be able to get to all these questions. The person also may not be willing to give you these questions. Some of these topics are relevant to a specific sector group (I will let you guys figure it out, not too hard)

 

As a practitioner, we categorise deal sourcing channels to two broader types: Proprietary and Intermediary. Proprietary includes top-down research, and personal networks. Top-down is the most systematic way, you first identify the broader sector you want to invest in, then the sub-sector, niche market, then the leading companies in the niche market. After picking out the leading companies, you try all the methods including personal networks and cold-call to get in touch with the company and persuade (Yes! persuade, 'cuz it's very competitive if you want to invest in the best companies) them to accept your investment. Personal networks: let every one of your friends know you are an investor and they'll refer deals to you when their or their friends' companies need money. You also need to extend your networks by attending industry conventions, forums to know more people in the industry, which is actually more effective as your personal friends usually won't generate much deal flow, if any. Intermediary means source deals from financial agencies ("FA"). FAs help companies do fundraising and charge commission if succeeded. They will give you a bunch of BPs for free, you pick out the ones you are interested and do the rest of your job.

 

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