Deal source pros key to producing top-quartile market coverage

If there was only one takeaway from the 2015 edition of the Sutton Place Strategies Deal Origination Benchmark Report, it would be this: that deal sourcing remains both a challenge, as well as an opportunity for general partners to unlock value for their investors.

The report compares the “market coverage” of a PE firm, which is the percentage of relevant, completed private equity transactions with a sell-side advisor that the firm reviewed, against all PE firms as well as their peer group. The results are based on the analysis of Sutton Place Strategies’s over 170 clients that qualified for inclusion.

Average market coverage of 18.6 percent is down slightly compared to 19.3 percent in 2014. If you are a private equity professional you might be thinking, “But our firm’s deal flow is up over 10 percent compared to last year, so how can market coverage be down?” What’s even more perplexing is that according to Sutton Place Strategies’s proprietary database of M&A transactions in the United States and Canada, the number of completed transactions in the first half of 2015 is actually down 4.4 percent from the same period in 2014.

So how can deal flow be up, closed transactions decline, and market coverage be relatively flat? There are two factors working together that help explain this. First, greater efficiencies in the M&A process are resulting in buyers getting “more looks.” In other words, a banker that may have shown a deal to 50 firms in the past, could now just as easily show it to many more. This explains the increase in overall deal flow among PE firms. However, since it continues to be a seller’s market, more owners are “considering” selling and talking to buyers but are really only ready to sell at their price. This mismatch in buyers and sellers expectations on valuation, and the increasing ability on the part of intermediaries to expand their network of potential buyers, may explain what on the surface may seem counter-intuitive.

Meanwhile, below the radar deals, run by either boutique advisors and brokers, or in rare instances even negotiated directly, continue to get done. These transactions by their very nature are not causing an increase in overall deal flow in the market. They are the hardest to find and close, and require a disciplined, long-term, data-driven approach.

This should give us that much greater appreciation for the firms that achieved the highest market coverage, particularly for transactions where the seller was represented by a boutique intermediary. Each of the top performers in the generalist, quasi-generalist, sector-focused, upper middle market, and lower middle market fund categories had a dedicated business development professional or team, which is especially noteworthy given that 54 percent of the firms included in the analysis actually don’t have a dedicated business development person. This is down from 59 percent when we ran the analysis last year. Given the trend, by the time we publish next year’s results, if you’re a PE firm without a business development professional you may very well be in the minority!

So why should becoming a more effective deal sourcer matter? Who really cares how your market coverage is trending and if you are top quartile or not? Tracking that your share of relevant qualified opportunities from which to make investments is increasing, and that you are outperforming your peers, should give both you and your LPs comfort around your future performance. Especially if you are finding deals outside the broadly auctioned market, among the lesser known, boutique deal sources. This won’t be easy, but it will be worth it.

How does your market coverage stack up?

AverageMaxMinTop Quartile
Market Coverage18.6%55.3%2.8%42.2%
Market Coverage Boutique Intermediaries12.0%47.2%1.5%35.8%
Market Coverage Most Active Intermediaries21.8%59.8%1.0%45.1%
Generalist PE Firms Market Coverage17.0%31.1%5.5%24.7%
Quasi-Generalist PE Firms Market Coverage17.1%41.3%3.1%33.8%
Sector Focused PE Firms Market Coverage22.5%55.3%7.5%43.4%
Upper Middle Market PE Firms Market Coverage38.3%50.2%27.6%44.6%
Lower Middle Market PE Firms Market Coverage9.3%26.3%2.8%20.4%

Source: Sutton Place Strategies