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Hunting for your next deal

David Teten of ff Venture Capital and Chris Farmer of General Catalyst Partners discuss private equity funds' best practices in sourcing investments

Would you invest in a company that only sold to one out of 80 leads?  Or a company that typically took one year and three professionals just to close a single client?

In fact, you've already made that investment: in your private equity fund.  According to our data, the median investor in private companies reviews over 80 opportunities in order to make one investment.  The median private equity fund required 3.1 investment team members to close one transaction in one year.

By the standards of most traditional sales processes, private equity origination is a very inefficient and labor-intensive process.  However, our research shows that private equity funds that employ a proactive origination strategy have consistently higher returns, driven by both greater quantity and higher relevance of incoming investment opportunities.

We recently completed the first-ever study of how private equity and venture capital funds originate new investments, published in full in the Winter 2010 issue of the Journal of Private Equity.  We drew on our personal work experience with leading institutional investors and in-depth interviews with over 150 funds globally.

Based on our study, we have identified five recommendations to improve the volume and relevance of dealflow.

1. Build a specialized outbound origination program. 
Growth investors with dedicated, large-scale sourcing teams are almost all top-quartile performers across stage, vintage, and sector. The largest practitioners of these programs – including Battery Ventures, Great Hill Partners, Insight Venture Partners, Platinum Equity, Summit Partners, TA Associates, and TCV — typically have between 0.75 and 1.25 dedicated deal sourcers for every generalist investment professional.

Summit Partners and TA Associates have leveraged their origination programmes to move into later stage buyouts.  Middle market private equity firms such as the Riverside Company have developed a broad network of 24 senior, focused deal originators to produce top quartile results in 8 of their last 9 funds .

2.  Create opportunities, instead of waiting for opportunities to appear.
A number of the funds we studied use an origination approach that allows them to proactively co-create companies or opportunities.  Frontenac Company uses a “CEO1ST” strategy, partnering with “deal executives” to source investments in these executives' focus industries.

3.  Use deal signals to look for targets which are both attractive investments and are likely to welcome an outside investor.
In order to filter the universe of companies, some investors specifically reach out to companies flashing  relevant “deal signals”.  These investors are exploiting the wealth of information about private companies available online, increasingly leaked via social media.  For example, an increase in internet traffic is usually a sign of customer traction.  A family-run company that hires an outside manager is flashing a signal that the firm may welcome an outside investor.  Navon Partners has built an automated platform for sourcing new transactions based on these signals.

4.  Leverage social media.
Historically, institutional investors kept their investing strategies very discreet.  However, today about 10-15 percent of the 1,000 active venture capitalists blog, according to Jeff Bussgang, general partner of Flybridge Capital Partners.  These investors have found that openly discussing their investment theses increases their perceived expertise and trustworthiness, and thus generates dealflow.  MCM Capital, a lower-middle-market private equity fund, has seen significant increase in deal flow as a result of their social media initiatives.

5. Install a professional CRM system.
A surprisingly high number of funds do not have a formal CRM system.  EquityTouch  found in a 2009 survey of 61 private equity funds that 37 percent were using no formal CRM application; instead, they were typically using only Microsoft Outlook and Excel.  Tim Lasonde, CTO of Equitytouch, observed, “What we are finding in the market is that the paradigm shift to the web 2.0 and collaboration mentality is hitting the alternative asset community last (slower).”  We asked one partner why he reported that he spent about an hour per day keeping notes on his work in his CRM system.  He said, “Because my boss said that I won't get paid if I don't.”