My friend Ryan Mullins joined Elm Park Capital (EPC), a private credit fund, in March of 2016 with the objective of developing a dedicated business development role. As Mullins points out in this ASM interview, this was not common practice at the time. Investment firms in the lower middle market and middle market did not typically have dedicated sourcing roles, but the market was growing far more competitive.
Sourcing Private Investments: An Increasingly Competitive Landscape
Sourcing statistics from the private equity industry at the time provide an interesting parallel. That same year data research firm Preqin reported that 36% of private equity buyout managers surveyed claimed that sourcing attractive investment opportunities had become more difficult. Bain’s 2017 Global Private Equity Report cited that managing directors at private equity funds were allocating 30% of their time to sourcing and networking activities, and that they were increasingly working with operating partners and formal advisors that dedicated 50% of their time to this effort. In the time that has elapsed, the competition has only grown, and increasingly this role is common at established funds.
To emphasize exactly how competitive this has become, I think it helps to look at how capital is raised today. Per the 2020 Global Private Equity Report published by Bain Capital, the classic LBO fund is in decline:
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.
In a world of abundant capital, the need to communicate precisely what you are looking for becomes hugely important to a fund’s success. I cannot cover the entire interview in this post, but I thought I would highlight a few of the challenges Mullins faced building this function at EPC.
Interview: Creating the Private Credit Business Development Role
Understanding how Mullins successfully created this role provides an interesting perspective. In my opinion it helps explain what this role really involves, and for those interested in business development, what will be expected of them in similar roles. In this post I thought I would cover just a few of the topics addressed in the interview.
- Building a network
- Identifying attractive investments
- Developing an investment pipeline
Building a Network in Private Credit
Mullins claims that when he first got started, he took a “boil the ocean” approach. He attended conferences and reached out broadly to private equity groups based on the check size Elm Park Capital was targeting. Over time, this approach narrowed. Industry was the first variable EPC used to filter opportunities.
By way of example, Mullins cites a willingness to tackle the “complexities of healthcare,” which allowed the firm to specialize while developing comfort with elements that other firms might have trouble with, like reimbursement risk. As the specialization grew across industries and credit type, the network also became more focused, and conversion improved.
Please see the interview for Mullins’ approach to generating repeat business with private equity funds and commentary surrounding geographic sourcing strategy.
Identifying Attractive Investments
As Mullins emphasizes multiple times throughout the interview, an investment opportunity is only attractive if you can assign a decent probability to winning the process. This requires not only understanding the investment, but the market you are competing in as well. EPC looks for more challenging situations because the associated risk allows them to increase their targeted return.
For EPC, this means a willingness to tackle challenges or new industries other firms might find too risky. EPC was early to software lending for example, which may not sound risky today, but there was a time that the investment community shied away from this space.
As it relates to specific underwriting challenges, Mullins cites a willingness to dive into the historical detail of a target company to understand a large one-time aberration in financial performance. Understanding the history allows them to get comfortable with a track record that might otherwise be too much of a “red flag” for a competing capital provider.
Developing an Investment Pipeline
At EPC, Mullins stated that on average the firm will look at ~1,300 opportunities in a year and close on 8 or 9. This process generates a substantial amount of data, and the better a firm is at managing this data, the more likely they are to identify competitive advantages. This requires systems to both manage the process and evaluate what the firm is doing well. Please see the interview to hear how Mullins built this system.
- 2:00 Moving to business development from an underwriting background
- 4:04 Two strategies: Working with sponsors and working directly with companies
- 5:30 Diligencing a private equity fund
- 6:00 Ideal investment opportunities
- 7:15 Getting comfortable with red flags
- 9:40 Getting comfortable with one-time issues
- 11:20 How the definition of an attractive opportunity evolves
- 12:10 Lending money at the fund level (PE fund)
- 13:45 The importance of messaging
- 17:10 “Boil the ocean” vs targeted approach
- 23:40 Why you need to know your capital partner
- 25:18 The conference circuit
- 27:10 The lender list
- 31:10 Pros and cons of sourcing via investment bankers
- 32:43 Sourcing through other lenders
- 34:10 Sourcing by city
- 42:10 The sourcing funnel
- 47:10 Understanding why you are losing deals
- 50:40 Sourcing funnel statistics (1,300 deals reviewed, 9 investments made)
- 51:51 Getting into business development