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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: Wiley Finance Editions
- Sprache: Englisch
Master the navigation of private equity deals from sourcing to exit with this comprehensive guide The Private Equity Toolkit: A Step-by-Step Guide to Getting Deals Done from Sourcing to Exit offers readers the first complete guide to executing a private equity deal from start to finish. Written by an accomplished professional with twenty years of experience in the private equity space, this book is perfect for current private equity analysts and associates, as well as business students and professionals seeking to enter the private equity field. This book covers every stage of the private equity process, from sourcing the deal to company exit. It provides a systematic overview of how to: · Originate attractive investment opportunities; · Generate superior deal insights; · Form effective working relationships with management teams; · Add value on portfolio company boards; and · Achieve profitable investment exits. The Private Equity Toolkit equips its readers with actionable frameworks and proprietary tools that can be applied on a daily basis in the private equity industry. The content found within is designed to be current and helpful for years to come and appeals to a global audience.
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Veröffentlichungsjahr: 2022
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Table of Contents
Cover
Title Page
Copyright
Dedication
Preface
Chapter 1: First Thoughts on Deal Sourcing
Chapter 2: Thematic Deal Sourcing
Chapter 3: Opportunistic Deal Sourcing
Chapter 4: Deal Selection: Eliminating the Wrong Deal
Chapter 5: Deal Selection: Identifying the Right Deal
Chapter 6: Assessing the Top Management Team
Chapter 7: Analyzing the Business Plan
Chapter 8: Valuation
Chapter 9: Deal Structuring
Chapter 10: Deal Execution: Transaction Process and Due Diligence
Chapter 11: Deal Execution: Legal Documentation
Chapter 12: Adding Value Through Active Ownership
Chapter 13: Exit Strategies and Deal Monetization
Acknowledgments
About the Author
1
First Thoughts on Deal Sourcing
Introduction to Deal Sourcing
Deal Sourcing Strategies
Assessment of Your Current Deal Sourcing Capabilities
Where Do Deals Come From?
2
Thematic Deal Sourcing
The Benefits of Thematic Deal Sourcing
Thematic Deal Sourcing: ICEBERG Roadmap™
1. Identify a sector theme and build aninvestment thesis
2. Conduct an in-depth analysis of the selected industry
3. Elaborate on your knowledge by mapping out key players operating in the industry
4. Build a network of experts and company executives to fill knowledge gaps
5. Establish a long list of potential deal targets and initiate coverage of these companies
6. Rank the companies by attractiveness and approach two or three potential deal targets at a time
7. Go visit companies to convert deal ideas into real transactions
Notes
3
Opportunistic Deal Sourcing
Developing an Edge in Opportunistic Deal Sourcing
DATABASE Roadmap™ for Opportunistic Deal Sourcing
Opportunistic Deal Sourcing: DATABASE Roadmap™
1. Develop a clear point of view about what kind of deals your fund wants to target
2. Articulate a concise and memorable message about your mandate
3. Team up with intermediaries who consistently add value
4. Add new relevant connections to your network
5. Build a strong brand
6. Apply creative thinking to supplement your opportunistic deal flow
7. Set-up a dedicated digital platform to manage your deal origination workflows
8. Establish a business development team fully devoted to deal sourcing
Notes
4
Deal Selection—Eliminating the Wrong Deal
Introduction to the Deal Selection Process
Eliminating the Wrong Deal Through Negative Screening
Notes
5
Deal Selection—Identifying the Right Deal
Positive Screening Framework
Notes
6
Assessing the Top Management Team
Management Practices in Private Equity
What Makes a Great CEO
What Makes a Great Private Equity CEO
Management Assessment
Notes
7
Analyzing the Business Plan
Introduction to Business Plan Analysis
Typical Issues in Business Plans
Business Plan Analysis Framework
1. What does this company do? Does it need to exist? What customer need does it serve?
2. What macro factors are likely to affect this business during my investment horizon?
3. What do I need to know about the industry to put the company's business plan into context?
4. What are the key building blocks of this company's business model?
5. How is this company positioned at present compared to its competitors?
6. What does the company do well and what does it do badly?
7. How has this business done historically?
8. What 5-year projections am I underwriting as an investment base case? What are the key sources of value creation during my investment horizon?
9. What are the risks? What is my downside investment case?
10. Does my investment case add up?
Notes
8
Valuation
Value, Price and Cash
Valuation Metrics
Valuation Methods
From Valuation to Pricing
Notes
9
Deal Structuring
Capital Structure
Management Incentive Plan
Advanced Deal Structures
Notes
10
Deal Execution: Transaction Process and Due Diligence
Transaction Process
Due Diligence: Introduction
The Ten Principles of a Good Due Diligence Process
Due Diligence: Key Workstreams
Notes
11
Deal Execution: Legal Documentation
Notes
12
Adding Value Through Active Ownership
Active Ownership: Value Creation Strategy
From Paper to Action: 100-Day Plan
Governance and Reporting
When the Deal Goes South
Notes
13
Exit Strategies and Deal Monetization
Exiting a Minority Transaction
Exiting a Majority Transaction
Exit Timing
Conventional Exit Routes
IPO
Strategic Sale
Sponsor-to-Sponsor Buyout
Alternative Deal Monetization Strategies
The Finishing Touch: Ensuring a Successful Exit
Notes
References
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Chapter 9
Chapter 10
Chapter 11
Chapter 12
Chapter 13
Index
End User License Agreement
Guide
Cover Page
Table of Contents
Title Page
Copyright
Dedication
Preface
Acknowledgments
About the Author
Begin Reading
References
Index
End User License Agreement
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THE PRIVATE EQUITY TOOLKIT
A STEP-BY-STEP GUIDE TO GETTING DEALS DONE FROM SOURCING TO EXIT
TAMARA SAKOVSKA
Copyright © 2022 by Tamara Sakovska. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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To my family
Preface
The Private Equity Toolkit aims to be a book like no other in its field. It is the industry's first practical reference guide to cover all critical aspects of private equity deal execution, from sourcing to exit. As an experienced deal practitioner, I focus on the technical fundamentals and practical judgment skills required by investment professionals throughout the entire lifecycle of a private equity transaction.
This book will introduce you to a number of my proprietary frameworks, checklists and cheat sheets that will enable you to develop your own personalized blueprint for originating, evaluating, executing and monetizing private equity investments. With The Private Equity Toolkit by your side, you will be able to dive straight into actionable advice to address your most pressing needs, including:
Building a solid deal origination capability through thematic and opportunistic deal sourcing (
Chapters 1
,
2
and
3
);
Identifying the best deal opportunities for your investment mandate and saving time by eliminating the rest (
Chapters 4
and
5
);
Evaluating the quality of the top management team you are seeking to back in your private equity investment (
Chapter 6
);
Analyzing the business plan of an investment target, identifying the main drivers of value creation and developing your own investment base case (
Chapter 7
);
Performing company valuation and robust deal structuring, for both majority and minority investments (
Chapters 8
and
9
);
Pursuing best-in-class deal execution through rigorous due diligence and thoughtful negotiation of the main transaction agreements (
Chapters 10
and
11
);
Adding value to your portfolio business by establishing effective governance processes and implementing an ambitious yet realistic Value Creation Plan (
Chapter 12
); and
Monetizing your investments through conventional routes, or alternative exit strategies (
Chapter 13
).
Private equity is one of the most fascinating fields in contemporary finance. Private equity professionals get to explore promising investment themes, meet accomplished entrepreneurs, walk the factory floors of real businesses, determine the value of illiquid assets and engineer the main transaction terms, with heated deal negotiations often extending into the late hours of the night. Since private equity is an interdisciplinary field, successful investors need to master a wide range of skills. Thorough technical knowledge of accounting and finance does not suffice on its own and needs to be combined with solid commercial judgment and exceptional relationship-building skills. Those private equity professionals who want to succeed are expected to originate attractive investment opportunities, generate differentiated deal insights, form productive working relationships with management teams, add value on portfolio company boards and achieve profitable investment exits.
How do they acquire these skills at present? Mostly, on the job. Apart from the book that you are about to read, there appears to be no universal reference guide that one can turn to in order to get a systematic overview of the practical aspects of private equity deal execution, from sourcing to exit. When investment professionals start their careers at a private equity fund, they learn how to do their job from senior colleagues by following a “master—apprentice” training model. However, senior private equity professionals generally have little time to dedicate to coaching new hires because they themselves are spread very thinly, often consumed by live deals or portfolio company crises that always take priority. Another obstacle that young investment professionals face is a lack of opportunity to acquire more advanced and specialized skills—for instance, those relating to creating effective reporting guidelines for an investment target post-acquisition, managing an investment in distress or preparing a portfolio business for exit—as these situations arise less frequently within the lifecycle of a typical private equity investment. Given these challenges, it takes multiple years for anyone to become truly skilled across all the main aspects of the private equity profession.
My experience was no different when I started my own private equity career a few decades ago. There was no practical handbook that could walk me through the key principles of private equity investing. I had to learn on the job and am grateful to all my senior colleagues who generously shared their knowledge with me. During my formative years as an investment professional, I thought it might be a good idea to start collecting various strategies and checklists that I came across on various transactions in order to create a single sourcebook to support me in my day-to-day work. Over the years, I incorporated a number of additional useful concepts that I discovered by reading books written by experts operating in adjacent business fields, such as mergers and acquisitions, value investing, equity research, behavioral finance, strategy, sales and marketing, business operations, restructuring, organizational behavior and corporate governance.
It took me a number of years to test the multifarious concepts in my “home-made” private equity primer on real-life transactions and transform them into a series of simple, actionable frameworks to underpin key decision-making principles that—in my opinion—apply best to each phase of a private equity investment, from sourcing to exit. This extensive compilation of ideas and multidisciplinary best practices formed the basis of my personal toolkit that I could turn to every time I needed inspiration or wanted to expand my professional repertoire. These proven techniques, together with the key lessons I learned during my own investment career, represent the core of The Private Equity Toolkit.
Remarkably, to this day, there is still no single finance book that can adequately fulfill the role of a practical “how-to” guide for the private equity industry. Even though there have been many useful private equity titles published in the last 10 years, you will quickly see that they are either academic textbooks that focus on theoretical principles, or private equity “war stories” that highlight prominent transactions in the industry. So far, not many private equity deal practitioners have taken the time to step out of the deal frenzy and write a practical reference guide capturing the industry's best practices across the private equity deal lifecycle. The Private Equity Toolkit intends to fill this gap and become the industry's missing manual.
The incessant growth of the private equity industry has created increased demand from curious professionals—such as yourself—who seek to embark on an investment career and look to acquire practical knowledge of the main skills required by the private equity profession. The Private Equity Toolkit will serve as a helpful guide for business school students, investment banking and consulting practitioners exploring a private equity career, as well as private equity professionals who are just starting their journey. Even though I assume that you possess a basic background in corporate finance and accounting, I made a deliberate effort to make this book as accessible as possible to a wide audience of readers by presenting the content in plain English, skipping graphs and equations and suggesting additional resources as I step through the chapters. While The Private Equity Toolkit primarily reflects my own subjective investment experience and utilizes stacks of personal notes, it is not entirely devoid of academic rigor. In fact, in preparing this book, I have performed extensive research of each topic across both the relevant academic literature and scholarly research in order to capture the most prominent findings and incorporate what I considered to be pragmatic, actionable advice.
Still not convinced? The chapter-by-chapter outline at the end of this section provides more insight into how you might be able to enhance your existing knowledge and optimize your own approach to private equity deal execution, from sourcing to exit. Use The Private Equity Toolkit as a reference guide and feel free to jump directly to the most relevant chapter whenever you require targeted support during a particular phase of a private equity investment. Once you've taken a look at the overall book structure, let's delve into the critical components of every deal that will make up your own private equity toolkit.
Disclaimer
While this book discusses at length my own approach to making decisions at every phase of the private equity transaction lifecycle, I am not offering any investment, legal or tax advice.
How to Get in Touch
If you have comments or suggestions, why not share them with me so that I can incorporate your thoughts in the next edition of this book? I welcome your contributions and feedback. Thank you! Please email me at: [email protected]
Chapter 1: First Thoughts on Deal Sourcing
Key Topics:
Why deal sourcing remains an obscure field
Six action steps to take today to enhance your deal origination prowess
Proven deal sourcing strategies and the search for the mythical proprietary deal
How to assess your current deal sourcing capabilities
Key trends to look for now to spot future private equity deals ahead of others
Chapter 2: Thematic Deal Sourcing
Key Topics:
Take the mystique out of thematic deal sourcing with the ICEBERG Roadmap™
An effective way of breaking down your deal search into simple, executable steps
How you can systematically generate promising investment themes
Best practices for mapping out an industry, finding deals and meeting sector experts
A time-tested strategy for approaching companies directly
How to make the most out of your first meeting with a deal target
Chapter 3: Opportunistic Deal Sourcing
Key Topics:
Develop an edge in opportunistic deal sourcing with the DATABASE Roadmap™
No luck required: why having a clear focus pays off in an opportunistic deal search
Actions you can take now to get the most out of your professional network
How active brand management can help your fund stay top of mind
Creative ways to supplement your opportunistic deal ideas
How to manage your deal origination workflows effectively and effortlessly
Does a dedicated business development function work for everyone?
Chapter 4: Deal Selection: Eliminating the Wrong Deal
Key Topics:
Why killing deals is as important as doing deals
How skilled investors overcome biases and minimize investment errors
Why the best investment of your career might be a deal you never pursue
Nine deal breakers you need to check for before proceeding on any deal
Chapter 5: Deal Selection: Identifying the Right Deal
Key Topics:
Save time and effort: why it makes sense to evaluate the transaction dynamic first
If you choose to remember one thing about deal selection, make it the business model
The four most common sources of competitive advantage for any business
Forget the detail: just a few key financial metrics that matter for deal selection
How clever structuring can help you overcome valuation concerns
Chapter 6: Assessing the Top Management Team
Key Topics:
Why motivating superb managers is the key ingredient in private equity's secret sauce
Why the best CEOs are not the charismatic and articulate leaders we see in movies
What makes the job of a private equity CEO among the most demanding in the world
Nine key qualities to look out for when assessing CEOs for private equity businesses
How you can apply the latest best practices in your assessment of management teams
Chapter 7: Analyzing the Business Plan
Key Topics:
Why skilled investors explore business fundamentals before diving into the numbers
Key problem areas to spot immediately in every business plan you review
How to poke holes in overoptimistic projections and make your investment case add up
Ten cold, hard questions that every solid business plan needs to address
My trusted business plan tool:
Master List of Most Common Drivers of Value Creation
Chapter 8: Valuation
Key Topics:
Enterprise value, headline price and cash consideration: why they are each different
How experienced investors use flawed valuation methods and still get to the right answer
Seven valuation metrics and six valuation methods I like (and hate) to use
Two valuation approaches for those times when you find “difficult to value” companies
You've done the valuation: How much will you pay to win the deal?
Chapter 9: Deal Structuring
Key Topics:
Capital structure considerations: what type of leverage to use and when it is too much
Management Incentive Plans: target A, reward A and achieve A
Enhance your deal through earn-outs, earn-ins, escrows and vendor loan notes
Minority deals: negotiate robust exit rights or be held hostage by majority owners
Advanced deal structuring techniques for minority investments
Chapter 10: Deal Execution: Transaction Process and Due Diligence
Key Topics:
What to expect in a typical private equity transaction process
Don't “boil the ocean”: ten principles of a well-managed due diligence effort
Who does what and why you need it: an anatomy of the key due diligence workstreams
Chapter 11: Deal Execution: Legal Documentation
Key Topics:
Why you don't need to be a lawyer to provide valuable input in legal negotiations
How to translate due diligence findings into legal clauses in the deal documentation
My cheat sheet summary of common issues in the key transaction agreements
Chapter 12: Adding Value Through Active Ownership
Key Topics:
Develop your own success formula with a Value Creation Plan
Four value-accretive actions for every portfolio company to consider
Create powerful performance improvement momentum with a 100-Day Plan
Governance and reporting: strategic priorities of a well-run private equity board
When things go wrong: spot the first signs of company distress and take radical action
Chapter 13: Exit Strategies and Deal Monetization
Key Topics:
How to exit a minority investment (effortlessly)
Exiting a majority transaction: Should you time the market?
Conventional exit routes: an IPO, strategic sale or sponsor-to-sponsor buyout
Can't exit your investment? Alternative deal monetization strategies to the rescue
The finishing touch: exit preparation roadmap for every portfolio company
Acknowledgments
I owe a debt of gratitude to my family, who supported me throughout my book-writing journey and helped bring this project to fruition. A warm thank-you to my wonderful husband Frederik, who was the first reader of every chapter in the book (not always entirely by choice). I would also like to acknowledge the invaluable support of my children, August and Daria. Thank you for coming with me to my office during numerous weekends and inspiring me to persevere during challenging times. I also would like to thank my sister Julia, my parents and grandparents for instilling me with a strong work ethic and teaching me the importance of critical thinking.
I am fortunate to have an extraordinary group of friends, many of whom encouraged me to write this book and provided constructive comments on my manuscript: thank you, Stefan Loesch, Oksana Denysenko, Helena Clavel-Flores, Irina Grigorenko, Vittoria Stefanello, Leopoldo Carbone, Julia Shur and Oksana Tiedt. In addition, I am grateful to Lee Barbour for delivering first-class editing support, and to Emma Stefanello and Michael Majdalani for providing excellent research assistance.
I would like to express my gratitude to Eli Talmor, Dirk Donath, Giampiero Mazza, Joshua Rosenbaum, Joshua Pearl, Alex Emery and Ted Berk. Each of these highly accomplished individuals were kind enough to read my book and provide me with their personal endorsement.
A special thanks to everyone in the Wiley team who assisted me in making this book a reality: my acquisitions editor, Bill Falloon, my assistant acquisitions editor, Samantha Enders, my managing editor, Purvi Patel, and my Editorial Assistant, Samantha Wu.
Finally, I would like to say thank you to a long list of brilliant work colleagues who taught me everything I know about private equity and dedicated their time to developing my investment acumen early in my career. I can't name you all, but you probably remember the long hours we worked together and know who you are, folks. Thank you!
About the Author
Tamara Sakovska is a private equity investor, board director and the founder of Lavra Group. She has over two decades of finance and investment experience gained at Goldman Sachs, HarbourVest Partners, Warburg Pincus, Permira, Eton Park and Global Family Partners.
Tamara's investment experience includes originating, leading and executing leveraged buyouts, minority and control growth equity transactions as well as private investments in publicly listed companies. She has also invested in private equity funds-of-funds and structured strategic co-investment partnerships with institutional investors, corporations and ultra-high-net-worth family groups. During her investment career, she has gained in-depth, global transaction experience across 14 countries in the technology, telecommunications, energy, natural resources, real estate and consumer sectors, among others.
Tamara is a tenured board member with a strong track record of managing complex strategic and corporate governance issues in both publicly listed and private companies. She has extensive corporate governance expertise, holds a Diploma with Distinction in Company Direction, is a Chartered Director and a Fellow of the Institute of Directors (UK). In 2018, Tamara received the Director of the Year Award in the Chartered Director category. She currently serves as an Independent Director and Chair of the Nominating Committee on the boards of two public companies listed on the London Stock Exchange and the Nasdaq, respectively.
Tamara holds an MBA with Distinction from London Business School (UK) and a BA with Honors and Distinction in Economics and Art History from Stanford University (USA), where she graduated Phi Beta Kappa and received the Anna Laura Myers Prize in Economics.
1First Thoughts on Deal Sourcing
Key Topics in Chapter 1:
Why deal sourcing remains an obscure field
Six action steps to take today to enhance your deal origination prowess
Proven deal sourcing strategies and the search for the mythical proprietary deal
How to assess your current deal sourcing capabilities
Key trends to look for now to spot future private equity deals ahead of others
Introduction to Deal Sourcing
Private equity begins with finding a suitable investment opportunity. Preferably, a great one. The first three chapters of this book discuss exactly that—the process of finding a private equity deal that represents a perfect fit for your investment mandate. In my personal experience, I have found this to be a tedious and frustrating process. Why? The private equity industry has been operating for nearly half a century, yet there is no one source that educates others in a granular and systematic way about how to build a solid private equity origination capability. Therefore, I set out to put my own detailed thoughts and experience in writing in order to share my perspective with others about this complicated process. My aim is to be as thorough as possible so that, after reading these first three chapters, you will walk away with a couple of solid and useful frameworks that will positively transform your deal sourcing outcomes.
Let's begin.
Why is understanding deal sourcing important? There are two primary reasons. First, creating and sustaining a flow of high-quality deal ideas is one of the core competencies of a successful private equity professional. This competency resonates very closely with the perceived brand of every private equity fund and, eventually, with your personal brand. Every limited partner (“LP”) investing in private equity funds is looking to identify a team of rainmakers who can demonstrate that they are capable of developing differentiated investment themes, finding sustainable sources of deal flow and closing successful transactions. As you get more experienced in private equity, the people you report to will increasingly expect you to originate your own deals proactively.
The second reason is that deal sourcing—while being critical to investment success—remains remarkably obscure. There is extremely little written specifically about private equity deal sourcing and how to master it. The books on private equity that I have researched seem to include only a high-level discussion of this topic. If you are interested in private equity, chances are you regularly come across articles in the trade press discussing the challenges of finding a good deal. If you have attended private equity conferences, as I have, then you've also heard a good number of deal origination war stories. However, I wasn't able to find a single resource that sets out a detailed private equity deal origination framework in one place. Hence, I believe I can make a contribution to this area with my deal sourcing guide.
In my research, I was able to identify only one study, conducted by Teten and Farmer (2010), analyzing deal sourcing strategies across the private equity industry and outlining a number of actionable steps aimed at improving the deal origination process. Unfortunately, I could not use the valuable lessons of this study in my own career because this research was published many years after I had been tasked with originating my own private equity transactions. In the study, the authors reaffirm the importance of deal sourcing in private equity: it turns out that late-stage venture capital and growth equity investors with proactive origination programs are almost all top-quartile performers across stage, vintage and sector. This makes sense. You can now understand why LPs might be very interested in examining your firm's deal sourcing process in agonizing detail.
When I started my first private equity job at a firm focused on large leveraged buyouts (“LBOs”), I found the process of deal origination and initial review fairly exciting. It was great to think through numerous business models and admire new ideas. However, it was also extremely exasperating. I was a member of the consumer team and it was not unusual for us to analyze over 100 large buyouts a year, bring 10–12 deals to the investment committee and work on three or four full deal execution processes in order to close just one transaction that year.
Yes, you read that correctly: the goal of my team was to review over 100 potential deals in order to close one deal per year. If you are lucky enough to complete one transaction a year, you are right on track! Sometimes, even this modest goal was out of reach. For example, when a target company was sold through a highly competitive auction process, our team would often not be chosen as the preferred (or highest) bidder. This means that there were years when we, as a sector team, would close no deals at all. Yes, we would still review over 100 potential deals that year and close zero. Talk about a low-energy Christmas party.
This is a rather frustrating, yet typical, fact in private equity: a lot of work goes into deal sourcing yet there is no guarantee of a successful outcome. Sometimes several years will pass from your first meeting with the management of a potential investment target to the time they are ready to consider a transaction. Sometimes the company will even go through multiple rounds of ownership until the management team is prepared to meet with you again. Sometimes the company shareholders are finally ready to accept a private equity investment, just not one from your firm! However, the stars do align at some point and, with perseverance, you can manage to get a private equity transaction to a final close.
What influences the successful outcome of sourcing and closing a private equity transaction? If you had asked me this at the beginning of my private equity career, I would have said that there was a fair degree of randomness and luck in this process. It is about being connected and about maximizing your options by doing 1,000 things to cover more ground. And being in the right place at the right time. And balancing cold-blooded investment analysis with the animal spirits of a competitive auction. Back then, I would have said serendipity deserves its fair share of credit, too.
Would I give the same answer now? Actually, I would not. I no longer think of sourcing and closing transactions as a game of chance. While the rules of probability do apply to finding good deals, I think there are steps that you can take to skew the odds in your favor. Sometimes significantly. Depending on what your competitors are doing in your sector or country of focus, you can definitely enhance your deal origination prowess by a considerable margin. I have certainly seen this in my own efforts of sourcing private equity transactions.
First, let's take a look at a broad overview of these action points and then I'll delve into each one in more detail.
Commit
. Make deal origination an institutional priority and aim to create a sustainable long-term competitive advantage both for yourself as an investment professional and your firm through sourcing high-quality investments. This means dedicating time to deal sourcing throughout the year even when it seems like there is no time for it.
Organize chaos
. Deal sourcing is tricky because it is an informal process that involves many variables. Decision-makers change their minds. Companies get taken over by strategic investors and cease to be private equity targets overnight. What can you do when things seem out of your control? Attack the mercurial nature of deal sourcing by turning your reactive activities into a number of intentional and predictable routines. Systematize your efforts and turn them into a framework. Focus on perfecting your deal sourcing process and do not pay excessive attention to interim outcomes. A better process will eventually lead to superior results.
Conduct deep industry research
. Create a unique information advantage for yourself and your team by developing expertise in a couple of industry subsectors. Make sure you build a detailed knowledge base in these subsectors, generate your own insights and initiate a flow of proprietary deal ideas. How do you do that? I have spent many late nights leading various industry “deep dives” and have developed my own framework for tackling this exercise. I will share these tactics with you later in the book.
Prepare your firm to move quickly
. Institutional agility can be a remarkable advantage, especially in a highly competitive deal environment. It is important to provide regular updates to your firm, especially your investment committee and key decision makers, on the main investment themes that you are working on. The goal is to get as much support as possible and ensure that everyone is aware of the detailed knowledge your team has acquired through deep research. One of the best ways to do this is for your team to develop and share their proprietary analysis of a sector with the rest of the firm. That way, once you identify a suitable deal in this industry, your investment committee should already be warmed up. They will trust your team to come up with a differentiated “deal angle,” giving you the ability to move forward with confidence and progress the deal ahead of your competition.
Develop an efficient deal sourcing process
. Take a step back and identify the areas of your deal sourcing process where most of your time is wasted. Does it feel like you are busy creating too many options by doing 1,000 things? Are you attending too many meetings with intermediaries who miss the point of your mandate and bring deals that make no sense? Is your deal sourcing network fully optimized? Are your meeting notes well-organized, searchable, synchronized and easy to access, both in the office and remotely?
Once you have had an opportunity to reflect, try to come up with ways to streamline your deal sourcing process. Aim for the end result to resemble a clock with a precise Swiss movement. Instead of doing 1,000 things to cover more ground, reduce your efforts to the 10 most value-added activities and repeat them with precision 100 times. These numbers are arbitrary, but you get the point: abandon deal sourcing tasks that yield no result, focus on the most productive activities and pursue them in a disciplined manner. This process should free up some of your time and enhance the quality of deals under your review, both of which will boost the probability of a successful outcome.
Persist, smile, repeat
. Now that you have created a proactive deal sourcing work plan, make sure there are dedicated slots reserved in your calendar to keep the process moving. Deal sourcing should be relentless and tick away with the dependability of a clock. Do not be tempted to drop out of the deal origination process, even during busy times. You can simply do less deal sourcing work during busy weeks. The only way to beat your competition is to work smarter. Take the time to put necessary reminders in your system for any follow-ups and be disciplined about following through completely. Do your best to maintain a positive spirit when deals disappoint. Take a deep breath, smile, move on and start again. Deal sourcing is simply a fixed number of efforts, persistent and repetitive, that eventually result in a big payoff.
Originating new deal ideas can sometimes feel like a mammoth task, but taking small steps can make it much more manageable. Just a few hours a week of proactive and intentional deal sourcing work can make a big difference and help you stay ahead of your competition. As the old proverb goes, “Water dripping day by day wears the hardest rock away.”
Deal Sourcing Strategies
What sourcing strategies are out there? Generally, people in our industry talk about two types of private equity deals: thematic and opportunistic. Thematic investments are potential transactions that you identify proactively through the rigorous and granular research of a particular industry subsector, emerging trend or a specific investment thesis. Thematic deal ideas sometimes do not have any obvious catalysts and can take a long time to become actionable. Opportunistic investments rely on a more passive effort on your part: they are inbound transactions that simply land on your desk. Opportunistic transactions are typically a lot more actionable: there is often a motivated seller who wants to get a deal done within a specific timeframe. The majority of opportunistic deals are introduced by sell-side intermediaries, professional connections and, less frequently, friends or acquaintances.
Based on what I have seen in the private equity market, most firms tend to pursue both types of deal sourcing approaches in order to develop a sustainable flow of new investment ideas. Thematic deal sourcing helps you narrow down your area of focus and build a knowledge base, which in turn increases the probability of finding an opportunistic deal in which your firm can position itself ahead of the competition as the most credible buyer.
The longer I worked on both thematic and opportunistic transactions, the more I thought about how to optimize the deal search process for both types of deals in order to create an effective routine. It took me many years, with many ups and downs, to outline a set of steps for myself that were easy to follow and gave me confidence that I was being thorough in my work and spending my time efficiently. The effort of documenting my deal sourcing approach ultimately morphed into a couple of fairly detailed frameworks which I will describe later in the book. What was I trying to achieve? I thought that the holy grail of my deal sourcing activity was to find a proprietary deal, either opportunistic or thematic.
Finding a proprietary transaction is a true obsession of the private equity industry. What makes a deal truly proprietary? When the transaction is not widely known in the market and your firm is the only party having discussions with the target company, then you are working on a proprietary deal. Sometimes the deal can be semi-proprietary: a few other market players might be aware of it and circle the same target. However, it is possible that your firm may be ahead in its learning curve and, therefore, manage to agree a period of exclusivity, during which you can evaluate and execute this investment. There may be cases when your firm succeeds in engaging in a truly proprietary dialogue with a great business found through months-long thematic research, only to be told by company owners that they will invite additional bidders. Why? Mostly because multiple bids typically make price discovery more accurate and give the owners an opportunity to maximize valuation. In this case, your proprietary idea will enter the open market and, I can tell you from my own experience, it is a rather painful feeling.
Why is it so hard to find proprietary deals? The private equity industry has matured over the years and there are literally hundreds of new funds entering the industry across the globe each year. As information barriers diminish, company owners are getting more sophisticated too, and are far more likely to hire a professional adviser than deal with just one private equity fund in a proprietary transaction. So, why do private equity investors continue to obsess over finding a proprietary deal? Well, everyone likes a competitive sport. Also, finding a proprietary deal is a great opportunity to showcase your professional finesse and highlight your fund's distinct advantage to your LPs. Your fund investors will feel like they have gained access to an exclusive deal club and, provided your fund's returns do not disappoint, will be keen to invest in your next fund when the time comes.
Theoretically speaking, finding a deal outside of a competitive auction should result in a lower entry valuation too. As the only bidder, your fund may avoid having to overpay in order to secure the deal. However, I am not so sure that the notion of a more reasonable entry valuation holds every time. I can think of a number of scenarios in which your fund may decide to pay a fairly high valuation in a proprietary situation. For example, your sector expertise may enable you to take an informed view of unique value creation levers that exist only in this company and not in other comparable businesses. You might decide to pay a premium because your fund may value transaction certainty and seek to benefit from lower execution costs. These are just some of the reasons that might explain a higher entry valuation in a proprietary transaction. Teten and Farmer (2010) remark in their study that sometimes private equity firms agree to pay a higher multiple of earnings for a proprietary deal because it enables them to pursue higher quality targets to begin with and also add more value after the deal closes.
In summary, proprietary deals have become exceedingly difficult to find—but they are not just a myth of the private equity industry. It makes more sense to think of them as an infrequent but completely plausible phenomenon, like a solar eclipse. As rare as they are, we can still expect to experience them once, and hopefully even multiple times during our careers.
Assessment of Your Current Deal Sourcing Capabilities
Let's take an honest look at where you are at the moment. Do you think your firm has strong deal sourcing capabilities? To distinguish good luck from a solid origination process, it might be helpful to think through and answer the following questions.
Does your fund set tightly defined investment goals for the next 12–18 months? Does your firm have a well-articulated sourcing strategy?
Does your firm pursue a research-driven thematic deal sourcing approach? Are there specific investment theses that you are developing in your area of focus?
How many proprietary deals has your firm sourced and what origination strategies were most successful?
Does your firm capture detailed data on the deal pipeline? Are you able to analyze past and current deal flow with basic pipeline key performance indicators (“KPIs”)?
Do you know what proportion of deals your firm has seen that are relevant to your area of focus? How many deals has your firm missed? Of those deals that were missed, how were they sourced? Do you have access to the same deal source?
If your fund saw the deal and rejected it, is there anything in the investment thesis that you failed to detect that other firms were able to spot?
Do you maintain a list of potential deal targets? Do you use a tech-enabled solution that allows you to keep track of them easily? Do you reach out to them consistently and follow up? Do you keep in touch with companies that currently appear to have no interest in selling?
Do you record key takeaways from meetings and calls that various members of your team have had with a potential deal target over the years? Is this information stored centrally and easy to access?
Does your firm have a good system of keeping track and systematizing firmwide relationships, such as with banks, consultants, industry experts and other professional intermediaries? Are you able to rank your relationships based on the value they provide to your firm?
These questions, no doubt, represent a degree of self-reflec-tion and discipline that can seem hard to reach. If your firm does not follow most of these processes, do not worry. These procedures are fairly straightforward to establish and, once in place, they will produce substantial benefits. If your firm already operates in a fairly organized way, then you are already ahead of the game and any incremental deal sourcing efforts should result in an even greater tangible payoff.
Where Do Deals Come From?
Have you ever wondered how a deal actually originates? What factors propel private equity activity? And why do deals come in waves? The reason why I care about these questions is the following: if you understand what emerging trends are likely to spur private equity deal activity in the near future, you can focus your deal sourcing efforts on this arena and position yourself ahead of your competition. In other words, if you are more observant than others, you can try to figure out where deal activity might happen much earlier than anyone else.
One of the intriguing aspects of private equity deals is that they take place in both good and bad market conditions. Theoretically, most private equity deals should happen in a bear market. When the IPO window is closed, the public markets are pessimistic and banks are less willing to provide debt on attractive terms; thus the shareholders of target companies should view private equity as a more appealing financing option. This theoretical argument can be extended further: private equity funds themselves should be able to take contrarian views in a bear market and seek to invest heavily in a down cycle. This will allow them to pay relatively low entry valuations and generate attractive investment returns. Does this happen in reality? Not as often as it should.
My observation is that private equity activity as a whole ends up being quite pro-cyclical. Of course, there are disciplined private equity investors out there who abide by their strict valuation criteria and who avoid investing at the top of the cycle. However, most market participants are human and, therefore, are likely to succumb to hubris when they observe rapid economic expansion and rising stock markets. Valuations are high when the markets are optimistic; however, one can always justify paying a full price for a good business. A deal frenzy begins and eventually swallows the majority of market participants. This explains why deals come in waves.
Since little research exists that links emerging trends to the private equity activity, I found it useful to look at the field adjacent to our industry, namely that of mergers and acquisitions (“M&A”). There is an outstanding book by Bruner (2004) that, in addition to discussing nearly all key areas of applied mergers in impressive detail, addresses precisely this topic. Bruner (2004) looks at what drives the M&A deal activity and identifies areas of “economic turbulence.” Some of these factors provide a good explanation of the private equity deal activity and are useful to keep in mind in your deal sourcing efforts. They are as follows:
Geopolitical change
. Political decisions can radically change the attractiveness of certain markets. Any shifts in policy that affect the prosperity of the economy, taxation, social environment and corporate governance will have profound implications for private equity transactions. For example, I owe thanks (and deals) to the following geopolitical developments that influenced my private equity career: the introduction of the single currency in the Eurozone, the inclusion of certain Central and Eastern European states to the European Union, the admission of China to the World Trade Organization as well as market deregulation reforms that followed the economic liberalization in India.
Secular trends
. Examples of secular trends include long-term shifts in the demographic makeup, the need of labor migrants to sustain economic expansion, vast differences in wealth distribution across generations, rising obesity rates and distinctive preferences of younger consumers, just to name a few. Any sustainable long-term macro shift could provide a fertile ground for investment.
Changes in regulation
. Deregulation is typically very beneficial for businesses, as their growth becomes less constrained and they can play by the rules of the market economy. Companies typically need to rationalize their operations in order to compete. On the other hand, when regulation tightens, businesses often have a need for fresh capital in order to comply with the changes that might be as extensive as having to adapt their entire business model. There are second-order effects too, such as the rise of new entrants providing tools and services that aid compliance in the new regulatory setting.
Technological change
. Do you remember how the world worked 10 years ago? Technological advances can be very disruptive for companies. Apart from requiring additional investments in infrastructure and personnel, technological shifts might compel companies to alter their strategic direction and invest in new capabilities in order to survive.
Innovation in financial markets
. Increasing market sophistication has a direct impact on the private equity industry. Examples of complex transactions that added fresh momentum to the sector include the advent of the LBO and securitization of leveraged loans. The introduction of certain structural features in private equity transactions such as a “sale and leaseback” has been replicated across numerous private equity–backed businesses that own hard assets.
Changes in capital market conditions
. Buoyant markets enhance deal activity. During record market highs, even businesses with no earnings, no revenues and, sometimes, no customers get bought and sold. When the markets are very liquid and are forgiving of corporate shortcomings, hubris takes over the world. As I mentioned earlier, private equity activity, at least theoretically, should abate. It does eventually but, as a rule, a little too late.
There are a couple of other deal factors not mentioned by Bruner (2004) that are important to include in this discussion:
Industry disruption
. Private equity firms are generally enthusiastic about backing industry disruptors. Traditional classroom education providers, retail banks and insurance companies are examples of industries being disintermediated by new entrants backed by private equity investors. However, it would be fair to mention that private equity funds sometimes fail to spot a terminal inflection point in the industry and let disruptors attack companies in their own portfolio. For example, some of the biggest losses in private equity occurred when the business models of music publishing and brick-and-mortar retail companies were completely dismantled by the online competition.
Sectors with substantial capital requirements
. Sometimes there are entire industries that announce large capital expenditures that will need to be incurred by companies operating in that sector. Examples of such capital investments include purchases of new spectrum in telecommunication auctions, the move to hybrid or electric engines in the automotive sector, the development of new techniques to extract fossil fuels and financing the gradual switch to alternative energy sources in power generation.
Applying successful business strategies to new industries
. Private equity excels at identifying proven business models that can be applied to new sectors. On-demand services, asset-light operations, outsourcing, “buy and build” strategies are just a few examples of what has been replicated across industries. Private equity investors look for appropriate business analogies and think: If restaurants operate as a chain, why don't nurseries or schools operate as a chain?
Replication of successful deal types in new geographical markets
. When private equity arrives in a new geography, especially in emerging markets, first deals tend to happen in telecommunications, breweries and branded consumer goods. Why? Because straightforward deals happen first. Private equity funds always seem to be keen to pursue proven investment theses in new countries where there are enough imperfections to warrant a high return.
Is this an exhaustive list? By all means, it is not. You can probably come up with additional factors driving private equity deal flow that are relevant to your industry or geography. It is always worthwhile to keep a close eye on any emerging trends in order to anticipate potential transactions and stay ahead of your competition. As soon as you identify the areas of so-called “economic turbulence” that seem relevant to your investment mandate, rush to your desk to research them so that you can spot future deal flow before anyone else.
2Thematic Deal Sourcing
Key Topics in Chapter 2:
Take the mystique out of thematic deal sourcing with the ICEBERG Roadmap™
An effective way of breaking down your deal search into simple, executable steps
How you can systematically generate promising investment themes
Best practices for mapping out an industry, finding deals and meeting sector experts
A time-tested strategy for approaching companies directly
How to make the most out of your first meeting with a deal target
The Benefits of Thematic Deal Sourcing
Identifying, developing and monetizing an investment theme is a valuable skill. Thematic deal sourcing allows you to build an extensive knowledge base in a sector of your choice, develop differentiated insights and gain an information advantage over your competitors. Gaining deep industry knowledge helps to improve the quality of your investment decisions and provides you with a better understanding of deal targets operating in that industry. Your investment committee will have more confidence to move quickly in the competitive process if they know that you and your team have become experts on the subject, and your investment thesis is well thought out and credible because you have spent considerable time researching the industry.
Your industry expertise allows you to stand out from the crowd in a busy private equity marketplace. Deep sector research inevitably results in generating extensive (and potentially not widely known) information about key players in that market, and these companies might become interesting deal targets for proprietary transactions. Your sector knowledge will enable you to empathize with management teams on key industry issues and position yourself as a value-added partner of choice to them. Professional advisers working on deals in the sector that you know well will appreciate the fact that they do not have to spend time educating you about the industry and will be enthusiastic about engaging with you on potential transactions.
