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The reason they do it is because bankers actually DON'T have relationships with every single company of interest in the market - in fact, often the most interesting and undervalued companies are completely off everyone's radar.
As one real-life example, a couple years ago one "sourcing" PE firm found a relatively small tech company that was a cash cow... 50%+ EBITDA margins, and since it was in the middle of nowhere and in an obscure market, no bankers had ever heard of it or knew anything about it.
They sold it a couple years later and got a very, very high return - far above the 20-25% IRR that PE firms typically aim for.
Why did they get that high a return? Mostly because no one else had discovered the company - without bankers raising the price via an auction process, they got a much lower price for the company than they would have been able to get otherwise.
Sometimes PE firms do indeed go through bankers, but they try to avoid it when possible to get a better price and to find these hidden gems.
There are 2 problems with sourcing / cold-calling to find companies:
It's still very much a "needle in the haystack" model - even assuming you call dozens of companies a day, you still probably won't find that hidden gem all too often. The real-life example I described above was extremely rare, and it's something that might only happen once a year or once every few years.
It only works for middle-market and smaller companies - if a $20 billion company is in the market, everyone will know about it. Since TA and Summit are focused on MM companies the model works well for them, but it wouldn't be as viable for the likes of KKR and Blackstone.
(I guess a third problem is that most people hate sourcing / cold-calling companies all day, so it probably won't be your cup of tea.)
I couldn't agree more. Some of the most profitable business have never surfaced. They are small, hidden, and so successful that they don't even need to surface for financing needs.
Also, if you realize that price drives the value in all transactions then you can start to see where some of this value in created. Take some guy who owns a liquor store out in the boonies. He probably has great revenue generation and decent margins. The problem is the market for a small business is very illiquid. The bid ask spread becomes very wide. Instant value for a buy and hold investor. Find a few of the deals and diversify against the small business risk (more likely to go belly up).
So why aren't there more funds that do this? There just is not enough to go around. While the small business portfolio cannot feed the mega funds or even medium funds, it can easily support a small group of investors. Plus with Obama planning to cut small business capital gain taxes there could be some serious opportunities. Hopefully that doesn't make the market too efficient and close those bid ask spreads!
I would say it is primarily price driven. We focus very intently on deals in which we have a proprietary look given that we likely can pick it up for multiple turns less than we could through an auction process. We source a disproportionate amount of our deals through proprietary processes despite the majority of the deals we look at coming from bankers. It's all about price.
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"Sourcing Model" (Originally Posted: 04/28/2008)
I have been searching through past threads, trying to put together a list of MM PE firms that I will eventually try to interview with for a job. Through this process, I have come across several statements along the lines of "be wary of firms that make you source deals at the junior levels".
Besides reading the actual job description as it may be posted on a firm's website, or on a headhunter's website...is there some way of figuring out which firms use a "sourcing model" and which firms dont? Is this a function of size of the firm/assets under management? Thanks for your time.
There's no real way to distinguish which firms use a sourcing model. Sometimes on the responsibilities and job description portions of a recruiter's email it may say something to the effect of sourcing, but oftentimes they leave it out because they know they'll get less applicants.
It's not a function of firm size, either. TA, which is an 8 billion dollar fund, employs it, Summit, which is about a billion, has it as well. Thoma Bravo has a sourcing model, and they between 1 and 2 billion.
What is Cressey doing these days?
Cressey broke off to form Cressey & Co. All three namesakes claim the break up was mutual, but who really knows. I think TB is going to focus on business services, and Cressey is going to focus on healthcare services.
I only know this random trivia because I had an interview lined up with TCB last year and pulled out due to the combo of the sourcing model and the turmoil.
Just curious, but what attracts you to MM PE (vs bigger PE firms)? And I haven't seen these threads that warn of "sourcing" model - what exactly are the risks with this?
I think there are a lot more smaller PE shops in the Middle Market. I prefer to work for small companies as opposed to large firms.
Additionally, I work for a MM IB and find the deals to be a lot more interesting. In my opinion, it is less politics and more finance skills/business acumen oriented. Not to mention, the large cap deal machine has slowed considerably, whereas the middle market is still doing pretty well. My firm is still on track to have a pretty good year.
Don't get me wrong, BB's are a great place to work and so are the large PE shops. I interned at a BB, had a pretty good time but just felt that the large firm lifestyle was not for me.
"Sourcing Models" are not necessarily a bad thing. Some people prefer getting on the phones and sourcing deals, whereas I would prefer not to, but it may be unavoidable at smaller firms. The risk, I believe, is that you would just be on the phones all the time and not actually do any finance related work. Hope this answers your question.
That about sums it up. I suppose you commit yourself to never owning a G5, but first-class can generally suffice...or so I think.
CPHBRAVO,
You're a clown... Very insightful comment. Thank you for your valuable contribution.
I've never understood the concept of a sourcing model. I have worked at a small PE shop that only does a few $B+ deals a year for the past 3 years and I have never had to cold call or source a deal. Our bankers and family contacts are constantly calling us with CAs and OMs for review.
Does sourcing consist of calling bankers, other buyside guys, and/or company management?
Sourcing usually consists of contacting company management or bus dev departments of companies. My friends that are at shops with sourcing models have to generate a certain number of leads per quarter/month and their bonus compensation depends highly on it. In addition 1 or 2 of your cold calls are expected to turn into potential deals. The only deal experience one would get in that situation is if they source the deal, as well (or if all the other associates and analysts are too busy to work on it). From what I hear, it's pretty terrible unless you're incredibly self motivated. Otherwise it's easy to slack off and get stuck with a number of calls to make towards the end of the month or quarter.
I never had to source deals, but I worked for an investment RE firm (commercial only) and their "brokers" had to source their deals. Literally, they just called people all day. They would find an area where a property just got purchased and then call all the surrounding owners and be like, "such-and-such property sold for $5MM, did you know that your property could be worth that much?" Then they would find out if they were interested in selling, run a comp for the property and market it. It was shitty to sit and watch them do this all day, but in all honesty, 10 years from now they will all be severely wealthy. Part of RE is building a book of clients and they just buy and sell, or "trade" one property for another continuously. Just wasn't my cup of tea.
At the PE firm I am interning at, they actually have 1 MD that does sourcing almost exclusively. He has built himself a massive network of business brokers, CPAs, attorneys and executive managers from various industries so nearly all of the deals come to him. I'm not sure how many firms use business brokers but its probably a good option for smaller funds, although I suppose that a business broker is exactly what a sourcing analyst would be, except the analyst would be a lot cheaper, lol.
Sorry to revive this two and a half years later, but is "sourcing" more like selling or more like networking? I realize there is some overlap there, but you definitely take a different approach depending on which it is. If it's salesy, you try to push, but if it's networking, you typically try to build the relationship (thus, not obnoxious or annoying on the phone -- willing to set up a time to talk rather than forcing them to talk now, etc.). I would guess it is more about building relationships, and I feel like most CEOs wouldn't blow you off because that's part of their job too (especially if it's a well-known VC/growth equity/PE shop).
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