Private Equity Sourcing Strategy

Per the 2020 Global Private Equity Report published by Bain Capital, the classic LBO fund is in decline. An emphasis on identifying specific opportunities within certain industries and the need for specialization in an increasingly competitive environment is causing funds to focus their entire strategy on specific sectors or strategies.

Growth within the buyout category has also shifted significantly. For the first two-thirds of private equity’s relatively brief history, the industry was shaped by the classic buyout fund, one geared to hunt for value in a number of industries and sectors with a diversified portfolio. Since 2010, however, these classic funds have been losing share to specialists—firms that have carved out clear areas of expertise and exploited them aggressively, including hyperfocused subsector funds, growth funds, ESG specialists, long-hold funds, etc. The share of capital raised for classic funds has slipped from a recent peak of 80% in 2013 to 56% at the end of 2020.

Click on the link to learn more about specific examples offered including Vista, Audax and Roark in the larger, megafund category. The article also includes smaller funds, citing both Corten Capital and Cove Hill Partners.

In its 2017 edition of the Global Private Equity Report, Bain Capital reports that funds are creating specific sourcing roles to help identify opportunities:

Some PE firms are deploying their advisers in very specific roles. EQT uses experts on call, retaining former senior executives to help pursue assets in industries they know well. Temasek Holdings has taken a slightly different tack, building a network of well-connected executives in Europe and the US—such as PepsiCo CEO Indra Nooyi—who are retained to help with business development. KKR uses regional experts, such as the for- mer president and CEO of Bolloré Africa Logistics, to help expand KKR’s franchise in Africa. And Advent International has invested in about 70 part-time operating partners who are assigned to sector-specific investment teams to focus on sourcing deal opportunities in those sectors.

Based on discussions with private equity professionals, Bain estimates that a substantial amount of time is being devoted to this effort. By role, the amount of time allocated to networking is estimated as follows:

• 50% – Formal Advisors
• 30% – Managing Directors
• 25% – Senior Directors
• 10% to 15% – Junior Directors

Even with this effort, the report estimates that PE funds only see 18% of the deals that might be relevant to them. Please see the report for an excellent chart on page 44.

Private equity professionals are increasingly pointing to sourcing challenges as a new obstacle in identifying attractive opportunities.

“When data research firm Preqin surveyed buyout fund managers in late 2016, 36% of respondents said that it’s more difficult to find attractive investment opportunities compared with a year earlier, and just 2% said it’s easier. Like the latter stages of a gold rush, investors have to get smarter about where and how to dig.”

For every 100 investment opportunities that make it into the pipeline, generally only 1 or 2 of these result in a transaction.

In 1982 a young Steve Schwarzman, who at the time was an investment banker that chaired Lehman Brothers’s M&A committee, was advising CSX Corporation on the sale of two daily newspapers. Initial bids were submitted by three bidders.

1. Morris Communications $200 Million
2. Cox Communications $135 Million
3. Gannet Company $100 Million

In response, the client, CSX Corporation, was eager to move forward with Morris Communications, but Schwarzman advised his client to wait. Rather than reveal the bids to encourage Cox and Gannet to match or surpass Morris, he kept the sums concealed and organized a second round of sealed bids.

The objective was to convince Morris that the offers received were tightly grouped. Believing that the competition was tight Morris Communications raised their bid to $215 Million.

“Steve had a God-given ability to look at a transaction and make something out of it that others of us would miss.”

Warren Hellman, President, Lehman Brothers

Today a “sealed-bid auction” is common, but at the time it was largely unheard of. “‘We made it up as we went along,’ says Schwarzman, who credits himself with pioneering the idea.”