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“It is impossible to produce superior performance unless you do something different.”
In an investing context, “alpha” is a term used to describe a strategy’s ability to beat the market. Simplistically, it could also be thought of as excess return. Therefore, alpha from a deal sourcing perspective would be generating investment opportunities that your competition is not also seeing. In the current state of the private equity game, alpha generation in deal sourcing is essential given elevated competition for the precious few higher quality opportunities in the market.
While the deal sourcing role within private equity funds has evolved and grown more professionalized over time, there continues to exist several flavors of staffing and strategy. However, one thing is clear – the “order taker” model of reactively waiting for widely-shopped deals to find you simply because you have a fund will not survive over the long term. How then is a fund to produce leads that their peers are not also seeing? Here are some ideas for strategic consideration – figuring out the tactics is up to you.
- Develop a thesis. Sometimes this is easier said than done. The bottleneck with this approach is having the good idea to begin with, but deal sourcing professionals observe every deal that comes in the door and should be able to recognize patterns that point to good investment ideas. Once a sector has been chosen, the disciplined exploration and documentation of an industry’s trends, risks, opportunities, competitors, etc. will yield well-organized knowledge that can be used to approach targets and relevant referral sources proactively. Further, an ancillary benefit to developing a thesis is being able to respond quickly and with conviction to deals from that industry that come in through traditional auction processes. Everyone is looking for an angle in auctions – having a well-vetted thesis in the can is one of them.
- Cultivate deep relationships with proven executives from sectors you like. Many executives have enjoyed long-tenured careers within sectors relevant to your investing efforts and have the respect and contacts to show for it. Off-market deals tend to find their way to these industry luminaries, often before a business goes to a full auction. These individuals will give your firm added credibility in speaking with business owners and often add significant value post-closing. Therefore, you need to have an engine that identifies such individuals and nurtures ongoing relationships with them.
- Get smarter about marketing. Most firms are still trying to figure out what marketing means for a private equity fund. However, leaders on the marketing front have emerged and have resources behind an array of channels including email campaigns, print publications, social media, and participation in various in-person events as moderators, panelists, etc. The challenging part is getting ahold of the right metrics to quantitatively assess ROI, and the exercise is often muddled by the understanding that one deal can justify a year’s worth of marketing spend. You may have heard John Wanamaker’s famous quote, “Half the money I spend on advertising is wasted; the trouble is I don’t know which half.” Sophistication in private equity marketing means consistently driving down wasted advertising spend and not narcissistically gazing into the reflecting pool of vanity metrics at the top of the funnel. It means generating differentiated, actionable leads that turn into indications of interest.
- Purposeful, proactive interactions with intermediaries. Intermediary coverage has gotten harder, largely due to the proliferation of newer, inexperienced sourcing professionals that annoy busy investment bankers with meaningless check in calls. The good news is that you can do it better, and if you do it right, you’ll unearth hidden opportunities. This happens because by expressing proactive interest in specific sectors, you’ll trigger connections in the mind of intermediaries who can help with introductions to executives and/or businesses that are perhaps too small for a formal process. It also gives you something interesting to talk about besides the weather in their particular city and positions you as a source of value-added information.
- Go local. All things being equal, a fund should have a relative advantage over their competition in pursuing local deals. Perhaps this is because dealing with local parties feels inherently more familiar and mollifies certain anxieties surrounding deal discussions. Also, in most cities, the number of eligible lower middle market companies vastly outnumbers the list of private equity funds, so this creates a motivation to embrace and build a relationship with the local business community. In Orange County, for instance, there are around three million people and only a small handful of dedicated funds. The numbers are likely in your favor.
As always, I’m interested in your reactions and comments. Fire away with feedback about anything I’ve missed or your experiences with these strategies.
About ClearLight Partners
ClearLight is a private equity firm headquartered in Southern California that invests in established, profitable middle-market companies in a range of industry sectors. Investment candidates are typically generating between $4-15 million of EBITDA (or, Operating Profit) and are operating in industries with strong growth prospects. Since inception, ClearLight has raised $900 million in capital across three funds from a single limited partner. The ClearLight team has extensive operating and financial experience and a history of successfully partnering with owners and management teams to drive growth and create value. For more information, visit www.clearlightpartners.com.
Disclaimer: The views and opinions expressed in this blog are solely my own and do not necessarily reflect any ClearLight opinion, position, or policy.