At a recent roundtable discussion with private equity advisers, two actively discussed topics were the slowdown in deal activity and how to generate more investment opportunities. Reports indicate that middle-market deal activity decreased from 887 transactions in the first half of 2010 (most recent peak period) to 666 in the first half of 2012. With $430 billion of dry powder in the sector and decreased deal activity, one response is that more PE firms are adopting the model of a dedicated deal generation specialist to keep the pipeline full.
Before 2008 we tended to see the dedicated resource model adopted when a fund manager reached roughly $200 million in committed capital. For many firms, that represented the size at which the members of the team who were wearing the 'deal generation hat' became too busy with execution and oversight to devote enough time to business development. As firms hit that level of activity, deal generation started to become choppy, so they would often look at a couple of options, including potentially increasing the size of the deal team, engaging more buy-side intermediaries, connecting with senior executives who were between gigs or hiring a deal generation person.
From 2009 to 2011, there wasn't much new demand for business development (BD) professionals since PE fund managers had more pressing concerns with portfolio companies. However, demand for this function has picked up and we are seeing the role show up at smaller funds including those with under $100 million in committed capital. For smaller funds, hiring a dedicated deal generation professional serves a dual purpose; increasing deal flow and demonstrating to potential LP's that the firm has the resources to generate sustained deal flow.
PE firms looking to add a BD professional often underestimate the cost and the challenge of finding the right person. Our advice is to hire an experienced person whenever possible, but given the recent development of this role, and the number of deal generation professionals with PE experience, there isn't a deep pool of PE experienced BD talent. We have identified about 200 in the US.
Because it is a small number, and experienced people aren't going to leave a successful fund if they have carried interest, fund managers then look for originators in leveraged finance or rainmakers in investment banking. That can be the solution, but the BD role in private equity is quite different. While the basic attributes to be successful are the same (sales talent, finance training and a boat load of drive) it takes time for someone outside of the industry to adapt to the uniqueness of the role in a PE firm.
One major difference is the numbers game involved. Private equity firms typically quote a ratio of one hundred opportunities seen to one deal closed. Investment bankers or commercial lenders rarely talk about looking at one hundred opportunities to do one deal. Also, in most cases, the PE business development professional doesn't get involved much past the indication of interest stage so they don't participate in closing the deals they source. There is a different psychic return when you're involved in closing the deal than when you hand it off. That difference can require some adjustment in a BD professional's thinking when they transition to private equity.
Another challenge is that many lenders or investment bankers want to move into a private equity career and may view the BD role as a doorway to ultimately doing deals. If the fund manager is looking for a dedicated resource that will stay in the deal generation role, they may find down the road that they hired the wrong person.
To generate the optimal level of activity, PE BD professionals need to maintain relationships with a large number of intermediaries and regularly keep in touch. Hiring a very junior person can be risky because investment bankers and business brokers want to deal with an authoritative person who responds to them on a timely basis. What they don't want is someone who doesn't understand finance or can't tell them why their deal got turned down. This person needs to be more than a "hale-fellow-well-met" type. Investment bankers say it takes multiple contacts over a period of time for the BD person to penetrate their consciousness sufficiently to merit a first call, so the role requires both substance and persistence. Getting the first meeting with a referral source isn't difficult, but developing the relationship takes time and effort.
Proprietary deals-the Holy Grail for PE funds-don't come from sell-side intermediaries. They come from a variety of professionals including accountants, attorneys, lenders, advisers and executives. Those relationships have to be developed and maintained. Since there are thousands of potential referral sources, it would be impossible to contact everyone. Leveraging resources takes research, knowledge and experience.
Managing their time effectively when visiting a dozen or so cities each year, scheduling and meeting with hundreds of potential sources and staying on schedule requires this individual to have significant organization and time management skills. After they've done it one or two times they will have the knowledge, but how much does it cost to get the rookie up to speed?
Accomplishing all of the above requires attributes that are not possessed by everyone so it is not something that just anyone can do, particularly if they have multiple other activities on which to focus. Many PE fund managers have said: "We're in good shape because everyone on the team is involved in deal sourcing." That may be working for them, but the model of five people doing the job 20 percent of the time is not equal to one skilled person doing it at 100 percent.
The cost benefit analysis is pretty straight forward. If the dedicated BD person enables a firm to do one acquisition a year of a $5 million Ebitda company at, say, a half-turn less than a full auction priced deal, their value added is easily seven figures. If this person finds add-ons that result in a higher exit multiple they can add seven or eight figures of value to the fund. Additional payoffs come from earlier deployment of capital and the resulting management fees.
It is rare for a PE fund to adopt the dedicated deal sourcing specialist model and then revert to the previous deal sourcing strategy. Given the challenges of maintaining dealflow, the deal generation specialist position is on the rise.
Wayne Sills is the founder of Sills Associates. The firm assists private equity groups with executive search, assessment and selection at the fund level as well as the portfolio company level.