Deal Origination from a PE Investor's Perspective

Text Version of the Interview

Importance of Investment Bankers as Channel Partner

You can go back and look at the trajectory of the industry. Early on, if you could raise the capital, you could do deals. And there was a finite amount of capital that was raised by the enforcement levels and the KKRs. 

So private equity investors started out with the mindset that investment bankers are competition. Because of this, the investment banker, instead of doing a private equity deal, might go public or might sell to the strategic buyer.

As the industry has matured, private capital has developed into its own ecosystem, and investment bankers and deal sources are critical. Now, the mindset is that the running auction drives the price up. But, the plethora of buyers drives prices and leverage multiples up. 

People forget the critical role that investment bankers play in preparing a company for sale and creating a way for the management team to run an M&A process without totally disrupting the business. 

There are fees to pay, but I would argue that it's the market speaking. Selling a business is such a massive transaction, especially for a family-owned business. If they are willing to sell without proper consultations and attorneys, that business is questionable. 

Deal Origination of Private Equity Compared to Corporate Development

Many people mistake looking at them as competitors, which was more the middle innings of the private equity world.  

On the flip side, the corporate development guys will say, here come the crazy private equity guys that are using all this leverage and don't have any idea what they're doing. 

And these two worlds are breaking out of those stereotypes and meeting in the middle in many ways. 

But one of the most significant differences that remain would be around the timeframe. Strategic buyers can come in and look at an acquisition a hundred years from now, and private equity can't think that way because of their fund structures. 

How does private equity source deals? 

In the simplest form, it is a brand-building exercise which is the relationship between whatever the company is and each customer. It goes back to your initial comment about deal sources and intermediaries being a channel partner, not a competitor.

The complexity of building a private equity brand has to factor in lenders, deal sources, LPs, company owners, company operators are all a part of that brand. 

The massive amount of information available on the internet matters as it affects your reputation. That brand and character and good behavior and references are all really important. 

Two is customer focus. Really figuring out inside your organization who your customers are. As you watch the industry grow and mature and specialize, you see those constituencies breakout in terms of your channel partners and those you have to work with.

Lastly, you have to set up a system to filter deals; you gotta look at the numbers, bring a thousand deals in, you'll visit a hundred, issue LOIs on 20, and close 10. You have to think about it in almost a commercial fishing, filtering mindset in order to make good decisions in a really crowded market.

The Strategy of Developing Brand for a Private Equity Firm

The first thing I would say is to sit down with those groups, the execution team, the origination's team, and the capital or the LP originations team, and come up with a consensus message of what it is that you do. That needs to be consistent. 

It has to be simple because there are 2000 and 5,000 active private equity firms out there. How are you separating what you do from everybody else? 

The other piece of advice I would give is to go out and actively try to listen to a bunch of other people in private equity who've been successful, tell their stories, tell their elevator pitches.

If you don't go out and actively listen to how people tell the private equity story, you can start to believe your own BS that your story is unique. There's only so many ways to tell the private equity story. 

So, I think one of the hardest things in private equity is to come up on how to tell your story. 

The way that the deals are structured is not how you're going to differentiate yourself. At the end of the day, you gotta lead with trust. If you can build trust with the deal source or the management, you've got an excellent chance of winning. 

Are Values Included?

The way that we look at and do the math around deals is very standardized. Even after all the work that you do, LOI will look the same. The numbers look the same, the management incentive packages look functionally the same and in a hot market like the one we're in now, the winner wins by an eighth of an inch in terms of price and package.

And when that is the case, when there is so much commonality in terms of valuation, how will you break the tie? It's about who you like to work with. 

I like how they interact with my management team. I like how they interacted with the hostess at the restaurant we went to for the management dinner. Those things begin to matter. I think that values, trust and character, and friendship matter in an efficient market.

Delivering Value to Different Entities

First part of that starts with a deep understanding of what your customer needs. If you are dealing with an LP who's invested in 200 funds, they need the data in their form on time. 

If you're dealing with a family office that mostly deals with public securities and have one private equity vehicle, they love getting back to their roots where they built their own wealth.

If you are talking with small entrepreneurs, they love the annual meeting. They love to walk around, have a beer with our CEOs, and hear about how we did the deals.

Different people will care about different things

It is a one-to-one brand. Each of your LPs has a different nuanced and different agenda and you can't feed your LPs or your deal sources or your management teams through the trough. 

It's a one-on-one relationship with each of those constituencies. 

Managing Different Relationships Using Technologies 

If you go back to it, the independent sponsor model works so well because an independent sponsor goes out and they want to do one deal. 

As you try to build a scale organization in this competitive world, three, 400 people might take advantage of that scale while at the same time maintaining the one-to-one relationships and the quality, and knowing who your customers are in each of those constituencies. 

That's a ton of hard work to pull all that together. And it starts with great habits, great values, and great systems.

Building Out Systems in Completing Deals

It starts with an analysis of what your pipelines are going to look like. So let's say you're going to raise a hundred million dollar fund with just ten deals. It's not that hard to put together a very simple Excel spreadsheet that includes management meetings frequency, number of LOIs prepared and signed. 

The heuristics and pattern recognition of what the pipeline looks like tells what we have to put in the top of the fall. That tells you how many business development people you need to have. 

Your best tool there is just crack and open Excel, go to your advisory board members and your senior partners and really dig into the numbers, the pipeline, and the flow. That's step number one.

And then use a CRM system, whether it's Asana or Salesforce. 

How to Create Quality Relationships?

The only thing that works is building a really deep, sincere relationship that's based on trust and based on, I know what matters to you and what you are trying to achieve, and I'm aligned with that, and you understand what I'm trying to achieve and you're aligned with that.

How to Start Building Relationships?

So what I would say is go to a conference and make one friend. You do not go to conferences to get a stack of business cards. If you want to do that, just pay to register for the conference, get the attendee list. And you got the same thing.

Figure out how to go to events and make one friend that you feel like you know what makes them tick. Make a friend who is roughly in the zone that you're in and has a chance at some point of showing you a deal that you'd be interested in, and really think about what's one thing I can do to help this person along their journey over the next couple of weeks. That's where I would start. 

That it will be infectious. That will be the beginning of the brand that you're building as an individual. The next conference you go to, you'll call that person ahead of time, and the two of you will set up the dinner, and he'll invite the few other people that he knows. 

I'm going to start with a bunch of very high-quality relationships and make that go viral. I would say that's the beginning of brand building. And especially, now in this market, that is so efficient and so competitive.

What Value Do You Offer for That Person?

Share data, share your own network, listen and empathize with the challenges that they're having inside their company and try to figure out how to build their own network. These are probably the most valuable things you can do in a world where we're all yapping about figuring out how to focus.

So the greatest gift you can give somebody is to focus a hundred percent of your attention on them even if just for a minute. That's the number one thing you can do feeding back in the network.

Opportunity to Make Deals

At the end of the day, an M&A transaction is a massive, once-in-a-lifetime partnership for a lot of people, particularly business owners. It is a really long journey to get to that point where the single most valuable asset in my family's history, I'm going to trust you to help us do the next phase of growth. 

Figuring out many different ways to showcase what kind of partner and what kind of friend you are going to be is how you advance the ball there. 

You're going to have to figure out who the key advisors are and help them build relationships with the accounting firm, the wealth planner, and the family members.

You're actively looking for opportunities, not through your words, but through your actions to say, this is the kind of partner I'm going to try to be. And I think you gotta realize you're playing a long game. 

Red Flags

When you see a huge misalignment in character and values, it's a good time to go pencils down. I love hearing from a management team about their former partners or their early investors in a competitive market. 

There's always a rationalization about how they shafted them because they weren't adding a lot of value, or they weren't holding up there and bargain. But that's a meaningful data point for me; how they tell the story matters. 

For somebody working on artificial time pressure, time pressure is essential to make the decisions and get back to work. 

But I can't think of good investment decisions I've made over my career where I felt really rushed. Making haste is important because we all got stuff to do, but when the other side is really rushing you in an artificial way, that's usually a red flag of something that hops up. 

Business owners that are crushing it in a short-term market. There are some companies that did incredibly well during COVID, and that could be a total shift in the business model that has opened new doors as their competitors have struggled.

But it could be something that's just like a one-time market anomaly that probably raises a red flag as well.

The Decision to Buy the Company

Wisdom of the crowds. It's trying to find the balance of the people who have done most work and know the most about the deal. Making sure their voices are heard. 

And then figure out a measured way to bring in the pattern recognition and the heuristics from the senior partners. 

And, interestingly, those are typically misaligned. The people with the most experience also have the largest span of control and are probably less in the weeds on the specific transaction.

And then your newer junior people know every number in the deck; they've been up late at night, grinding it out. But they don't necessarily have the broad pattern recognition across multiple cycles and things like that. 

And one of my favorite things is trying to bring those two constituencies together. 

How Do You Assess All the Decision Points? 

It teaches your organization to listen and really invests a lot of time in what that looks like. The easiest thing in the world is to show up. 

Usually, the person who does the most talking in an investment committee discussion over my career is the person who's done the least work. They're probably doing the most talking as a defensive mechanism for feeling a little bit bad about not getting down in the weeds enough. 

Selecting Bankers When Selling a Company 

It starts with a good playbook and way in advance. Just because a banker keeps calling you doesn't mean you have to consider him. You need someone methodical who has a ton of experience and it's really important to align size. I don't want to be the smallest deal and the biggest deal that that bank does. 

You should have a scorecard that you share with the management team, the board members, whoever's going to be on that call with you, and force people, after the pitch, to write it down. 

I spend a lot of time figuring out who your point person is going to be, and you must align with that person. 

Another critical piece is, when they send in the fee proposal. The first breakpoint in that investment banks fee is probably one data point that tells me how convicted they are about the business. Those first breakpoints are really important.

Fee Negotiation 

I need to see their first volley. 

If one group comes in and their first breakpoint in the fee is at $600 million, and somebody else comes in and their first breakpoint is at $750 million, that tells me something. 

You can probably push them both, but what they think their first bid is a very powerful data point in that evaluation.

Best Tip for Deal Origination

A perfect execution partner is really good at zeroing in on four or five relationships and the ability to hyper-focus on adding value at those deals. But that would make them a crappy sourcer. The really good sourcing person is fed by the new conversation, learning that person, figuring out what matters to them at scale with lots of people. 

Cross-training is really important, and I would recommend every young person on the execution side figure out how to get a tour of duty with the sourcing team and the opposite is also true. But only get into sourcing if you really get fed by the activities that are critical to sourcing. 

You gotta have a long-term fair mindset. The market has matured, and building a long-term brand is far more important than just getting the next deal done instead of hitting the quarterly quotas because that will be a short and ugly career in business development.

And again, you got to be urgent; you got to follow the current metrics and drive that but play the long game. Don't just think about this year or this quarter.

Practitioners Struggling with the Skills Needed to Develop Relationships 

It's a different skill set to develop. If you'd go back, there are a bunch of great firms that are finally doing a better job of this. But for the most part, people are eventually trained to do the math, the execution work of getting a single transaction done and going through their career ladder. 

Someone good at sourcing is very different from a person who is awesome at execution. It makes no sense that you promote someone who is great at execution, but you require someone good at sourcing.