Building business development function at LMM firm

When building a business development (BD) or sourcing function at a lower middle market (LMM) fund, there are several best practices to follow and common pitfalls to avoid. Based on the most helpful WSO content, here’s what you need to know:

Best Practices for Building a BD/Sourcing Function:

1. High Conviction Sourcing Approach:

   • Focus on assets you are truly comfortable with. Start with industries or business types where you have expertise or a strong network.
   • Avoid chasing "cheap" businesses without quality. If you can't find cheap quality, aim for reasonably priced quality.

2. Domain Expertise:

   • Develop deep knowledge in specific verticals (e.g., software, services, etc.) to identify high-quality businesses. This allows you to become a trusted expert in those areas and build credibility with sellers.

3. Commercial Instincts:

   • Train your team to think beyond deal execution. A great sourcing function should evaluate valuation, leverage, management dynamics, and co-investor relationships while assessing business quality.

4. Leverage Relationships:

   • Build a network of brokers, bankers, and other intermediaries. While LMM brokers may not always be dependable, nurturing these relationships can still yield valuable deal flow.
   • Engage with CEOs and operators directly to uncover off-market opportunities.

5. Structured Process:

   • Create a repeatable and organized sourcing process. This includes tracking outreach, follow-ups, and deal evaluations systematically.
   • Use CRM tools to manage deal flow and ensure no opportunities slip through the cracks.

6. Team Collaboration:

   • Build a small, cohesive team that can handle multiple aspects of sourcing, due diligence, and execution. Ensure team members are versatile and can adapt to the "jack of all trades" nature of LMM PE.

7. Focus on Long-Term Relationships:

   • Be generous and fair in your dealings with intermediaries and potential partners. Structure incentives so that others succeed when you do, fostering loyalty and trust.

Common Mistakes to Avoid:

1. Overemphasis on Volume:

   • Avoid focusing solely on the number of deals sourced. Quality matters more than quantity, especially in the LMM space where resources are limited.

2. Neglecting Culture Fit:

   • Hiring BD professionals who lack alignment with the fund's culture or long-term goals can lead to inefficiencies and turnover.

3. Lack of Training:

   • Failing to train junior team members on both sourcing and deal evaluation can result in missed opportunities or poor-quality leads.

4. Ignoring Red Flags:

   • Don’t compromise on due diligence just to close a deal. Small businesses that seem "cheap" often come with hidden risks.

5. Disorganized Processes:

   • A sloppy or unstructured approach to sourcing can lead to missed follow-ups, poor tracking of opportunities, and inefficiencies.

6. Underestimating the Grind:

   • Sourcing in the LMM space requires persistence and resilience. Deals often fall apart, and it’s crucial to stay motivated and adaptable.

By focusing on these best practices and avoiding common pitfalls, you can build a robust and effective BD/sourcing function that drives long-term success for your LMM fund.

Sources: Why The Hate on Sourcing?, Leave banking to start a PE fund?, Q&A: I’ve held Pre-MBA MM LBO, Growth Equity and Venture Capital investment roles for funds with $500M+ AUM to $5B+ AUM, 7 Practical Buyside Recruiting Tips for IBD Analysts, Is it dumb to exit to LMM PE rather than starting in bigger (MF/UMM) opportunities first?