Changes in capital market conditions. Buoyant markets enhance deal activity. During record market highs, even businesses with no earnings, no revenues and, sometimes, no customers get bought and sold. When the markets are very liquid and are forgiving of corporate shortcomings, hubris takes over the world. As I mentioned earlier, private equity activity, at least theoretically, should abate. It does eventually but, as a rule, a little too late.
There are a couple of other deal factors not mentioned by Bruner (2004) that are important to include in this discussion:
Industry disruption. Private equity firms are generally enthusiastic about backing industry disruptors. Traditional classroom education providers, retail banks and insurance companies are examples of industries being disintermediated by new entrants backed by private equity investors. However, it would be fair to mention that private equity funds sometimes fail to spot a terminal inflection point in the industry and let disruptors attack companies in their own portfolio. For example, some of the biggest losses in private equity occurred when the business models of music publishing and brick-and-mortar retail companies were completely dismantled by the online competition.
Sectors with substantial capital requirements. Sometimes there are entire industries that announce large capital expenditures that will need to be incurred by companies operating in that sector. Examples of such capital investments include purchases of new spectrum in telecommunication auctions, the move to hybrid or electric engines in the automotive sector, the development of new techniques to extract fossil fuels and financing the gradual switch to alternative energy sources in power generation.
Applying successful business strategies to new industries. Private equity excels at identifying proven business models that can be applied to new sectors. On-demand services, asset-light operations, outsourcing, “buy and build” strategies are just a few examples of what has been replicated across industries. Private equity investors look for appropriate business analogies and think: If restaurants operate as a chain, why don't nurseries or schools operate as a chain?
Replication of successful deal types in new geographical markets. When private equity arrives in a new geography, especially in emerging markets, first deals tend to happen in telecommunications, breweries and branded consumer goods. Why? Because straightforward deals happen first. Private equity funds always seem to be keen to pursue proven investment theses in new countries where there are enough imperfections to warrant a high return.
Is this an exhaustive list? By all means, it is not. You can probably come up with additional factors driving private equity deal flow that are relevant to your industry or geography. It is always worthwhile to keep a close eye on any emerging trends in order to anticipate potential transactions and stay ahead of your competition. As soon as you identify the areas of so-called “economic turbulence” that seem relevant to your investment mandate, rush to your desk to research them so that you can spot future deal flow before anyone else.
2 Thematic Deal Sourcing
Key Topics in Chapter 2:
Take the mystique out of thematic deal sourcing with the ICEBERG Roadmap™
An effective way of breaking down your deal search into simple, executable steps
How you can systematically generate promising investment themes
Best practices for mapping out an industry, finding deals and meeting sector experts
A time-tested strategy for approaching companies directly
How to make the most out of your first meeting with a deal target
The Benefits of Thematic Deal Sourcing
Identifying, developing and monetizing an investment theme is a valuable skill. Thematic deal sourcing allows you to build an extensive knowledge base in a sector of your choice, develop differentiated insights and gain an information advantage over your competitors. Gaining deep industry knowledge helps to improve the quality of your investment decisions and provides you with a better understanding of deal targets operating in that industry. Your investment committee will have more confidence to move quickly in the competitive process if they know that you and your team have become experts on the subject, and your investment thesis is well thought out and credible because you have spent considerable time researching the industry.
Your industry expertise allows you to stand out from the crowd in a busy private equity marketplace. Deep sector research inevitably results in generating extensive (and potentially not widely known) information about key players in that market, and these companies might become interesting deal targets for proprietary transactions. Your sector knowledge will enable you to empathize with management teams on key industry issues and position yourself as a value-added partner of choice to them. Professional advisers working on deals in the sector that you know well will appreciate the fact that they do not have to spend time educating you about the industry and will be enthusiastic about engaging with you on potential transactions.
It sounds like there are only positives in a thematic deal sourcing process, right? Unfortunately, not. It is a time-consuming and resource-intensive task. It requires such an overwhelming effort on your part that it might be very tempting to return to your day-to-day reactive activities and abandon your goal of becoming an industry expert altogether. I have certainly experienced this feeling on more than one occasion, especially when working on sectors that I was less excited about. I felt like I certainly had enough to fill my days without taking a “deep dive” into a new sector.
What can make thematic deal sourcing less daunting? What I have found is that this task seems far less intimidating when thematic research is broken down into small, digestible pieces that form a checklist-like framework. It is much easier to check small items off your list than deal with one mammoth chore. Since I could not find such a detailed checklist aimed at a thematic private equity deal sourcing process anywhere, I put together this 7-step thematic deal sourcing framework myself. Here it goes.
Thematic Deal Sourcing: ICEBERG Roadmap™1
My framework is called the Thematic Deal Sourcing ICEBERG Roadmap™. Broadly speaking, the thematic deal sourcing process consists of the following steps:
1 Identify a sector theme and build an investment thesis.
2 Conduct an in-depth analysis of the selected industry.
3 Elaborate on your knowledge by mapping out key players operating in the industry.
4 Build a network of experts and company executives to fill knowledge gaps.
5 Establish a long list of potential deal targets and initiate coverage of these companies.
6 Rank the companies by attractiveness and approach two or three potential deal targets at a time.
7 Go visit companies to convert deal ideas into real transactions.
Let's go through these steps in greater detail so that you can understand how I developed this checklist and modify it as needed to create a framework that works for you.
1. Identify a sector theme and build aninvestment thesis