How PE firms can best distinguish themselves: buy-and-build and strong deal sourcing

By Nadim Malik and Brenden Gobell, Sutton Place Strategies

As private equity and M&A activity gains momentum in 2019, the question on everyone’s mind is, “How long can the current economic expansion continue?”

With purchase multiples at or near all-time highs and PE fundraising and dry powder at record levels, one can’t help but wonder how fund returns for recent vintages will be affected.

Not to mention all the competition: In 2018, SPS estimates that 1,400 different financial investors each led at least one transaction north of $10 million in enterprise value in the U.S. or Canada.

Perhaps the more important question to ask is: “How are private equity firms strategically adjusting to current market conditions to drive fund performance?”

As SPS assesses current trends and PE data, two areas where PE firms are successfully differentiating themselves in today’s market come to light: buy and build and deal sourcing.

Buy and build

The thesis behind add-ons, or the buy-and-build strategy, is intuitive.

Strategically, various smaller players in a particular market niche may well benefit from being parts of a larger platform, due to synergies created by economies of scale and reduced operational costs.

Financially, smaller deals typically trade at lower purchase multiples. And as you add to both the top and bottom lines with multiple acquisitions, you get not only wider profit margins due to the cost savings but expanded multiples at exit. That’s a double win for IRRs.

While not easy to execute, the buy-and-build strategy is backed by logic. SPS data shows that 2018 saw 2,043 PE add-ons of $5 million or greater enterprise value, completed by 689 different investors.

This compares with 1,903 add-ons by 666 investors in 2017 and 1,634 add-ons by 669 investors in 2016. That’s a 25 percent increase in deals over the past two years.

The three leading verticals for add-on activity during 2018 were industrial equipment and products, insurance, and specialty clinics and centers.

A breakdown of the most active PE firms completing add-ons in 2018 is below:

Deal sourcing

The rise of the business development professional over the past decade is a strong testament to what SPS has long advocated: Deal sourcing is one of the most vital aspects of a private equity firm’s success in a competitive market.

Effective sourcing demands functional metrics to assess market coverage of relevant deal flow, prioritize and strengthen intermediary relationships, and identify which intermediaries run the most limited vs. broad processes.

Deal flow needs to be rigorously analyzed in the context of a buyer’s intermediary universe, which paves the way for streamlining deal-sourcing processes via intelligent automation and achieving top-quartile fund performance.

In this spirit, SPS developed a new analysis based on the anonymized deal flow of 95 PE firms over the past two years, to examine topical trends.

The median number of unique, active intermediaries from which a PE firm reviewed deals in the past 12 months increased 20 percent to 194 from 162.

This year-over-year increase proves that PE firms are dramatically increasing the number of relevant intermediaries from which they are seeing transactions. If your firm’s deal flow came from the same number of sources year over year, it may be time to expand your network.

An ongoing debate among PE firms asks where they should focus their sourcing efforts, i.e., the more active well-established intermediaries typically running efficient processes with a high likelihood of closing or lesser-known intermediaries closing fewer, typically less competitive deals.

Let’s see what approach the industry pros take. The Best-in-Class Deal Originators, per the 2018 SPS Deal Origination Benchmark Report, shows 72% of their deal flow on average comes from intermediaries that show them more than three deals a year, compared with 62% for the overall market.

On the flip side, however, 71% of the unique intermediaries from which they see deals are boutique advisers that closed three or fewer deals a year.

Evidently, a holistic strategy to boost market coverage of relevant actionable deals strives to maintain consistent deal flow from those prolific banker relationships, while also continuing to focus on less active intermediaries often running more limited processes.

Hence, it’s not just emphasizing one category over the other; rather, all intermediaries should be prioritized and marketed to accordingly, with new relevant intermediaries added in a timely manner. It almost sounds too simple.

While the market remains heated, PE firms still have opportunities to differentiate themselves and drive fund performance.

Maybe you should take a hard look at the buy-and-build strategy. Alternatively, perhaps your firm can better leverage analytics and automation to improve your deal-sourcing effectiveness and closing rates.

Stepping away from the firehose of a hot M&A market and taking a strategic, data-driven review of how to best operate could pay great dividends down the road.

Nadim Malik is founder and CEO of Sutton Place Strategies, a provider of data and analytics for PE and M&A professionals to optimize their business development efforts. Brenden Gobell is director of client strategy and data insights at SPS. Reach them respectively at and or at +1 212-376-6129.