Private Equity Deal Flow: Best Practices + Strategy for 2024

As the competition for acquisition targets intensifies, PE deal flows backed by traditional brokered auctions are becoming less effective due to high valuations and crowded bidding.

According to PwC, the private equity market is increasingly embracing proprietary sourcing to secure better deals and avoid competitive pressures.

PitchBook also highlights a shift towards smaller add-on acquisitions as firms seek to create value through targeted, off-market opportunities.

Dan Kobayashi, President of SourceCo, weighs in:

“Proprietary sourcing isn’t just about volume; it’s about finding the right deals.”

This guide explores strategies for optimizing deal flow, leveraging technology, and building direct relationships with business owners to maintain a robust pipeline in any market condition.

TL;DR

What is Private Equity Deal Flow?

Deal flow refers to the process of sourcing, evaluating, and acquiring investment opportunities. It represents the volume and quality of potential deals that come through the door and encompasses the entire pipeline, from initial lead generation to final acquisition. A strong pipeline provides firms with diverse opportunities, ensuring they can be selective and strategic in their acquisitions.

Types of Private Equity Deal Flow

• Proprietary Deal Flow: Sourced directly from relationships with business owners, avoiding competitive auctions. This approach is favored for accessing off-market deals with better pricing and terms.
• Brokered Deal Flow: Involves deals presented through intermediaries like investment banks or brokers. While it provides volume, it often leads to competitive bidding and higher acquisition costs.

Dan Kobayashi, President at SourceCo, added:

“Proprietary sourcing isn’t just about volume; it’s about finding the right deals.” Quality deal flow aligns with a firm’s strategic goals and investment thesis, leading to better outcomes."

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Deal Flow Stages

• Lead Generation: The initial stage, often driven by relationship-building, targeted outreach, and leveraging networks.
• Screening and Evaluation: Filtering deals based on criteria like sector fit, financial performance, and growth potential.
• Due Diligence: A thorough analysis to validate the target’s financials, market position, and operational risks.
• Closing: Final negotiations and transaction structuring to secure the acquisition.

Recent Deal Flow Trends

According to PitchBook, firms are increasingly favoring add-on acquisitions due to their lower costs and alignment with buy-and-build strategies.

Additionally, high interest rates and market volatility are pushing firms to refine their sourcing strategies, making proprietary deals more valuable than ever. As Pitchbook's 2024 PE Middle Market Report states:

"As seen in 2023, sponsors continue to turn to the middle market for acquisition targets during a high-interest rate environment for easier financing and to enhance the market position of existing portfolio companies through add-on deals."

Best Practices for Optimizing Deal Flow

PE landscape is becoming increasingly more competitive. This requires dealmakers to adopt anuanced approach - ideally an approach that blends technology, relationship-building, and strategic foresight.

Here’s a closer look at how top firms, guided by insights from industry leaders and market research, are keeping their pipelines full.

1. Prioritize Proprietary Deal Flow

Private equity firms are shifting away from crowded brokered auctions toward proprietary sourcing. Tomos Mughan, SourceCo's CEO shared:

“Traditional deal sourcing is broken because it’s crowded and competitive. Proprietary sourcing is about connecting directly with owners who haven’t considered selling yet.”

The importance of direct relationships cannot be overstated; these connections often reveal off-market opportunities that traditional methods miss.

Dealmakers should therefore put more focus on regularly engaging with business owners, even when they aren’t actively looking to sell. These early connections build trust and lead to more meaningful conversations down the line.

PwC's midyear outlook further confirms this, as they see bilateral negotiations gaining traction as firms seek exclusivity in a crowded market.

2. Blend Technology with Human Expertise

Combining technology with human insight is key in staying competitive. As Dan Kobayashi noted,

“It’s not enough to rely on data; you need experienced team of people who understand the nuances behind those numbers.”

PitchBook data echoes this, showing firms that blend AI with human outreach achieve higher success rates in identifying quality targets.

As an example, at SourceCo, once we have a dialed-in process that produces results, we look for ways to automate primarily repetitive, low-value tasks.

This could involve third-party software, virtual assistants, or custom Python scripts. We are big fans of Clay; when you get into more complex automation, it has its limits, and it is not an easy tool to pick up, but it is an extremely cost-effective way to get started with research and outreach automation.

3. Stay Agile and Continuously Reassess Your Criteria

Markets evolve rapidly, and so should your deal criteria. As highlighted by PwC, adjusting strategies to align with changing market dynamics is crucial.

Tomos shares:

“You can’t just set your criteria and forget it,”

“You have to be willing to tweak your approach based on what’s happening in the market.”

4. Focus on Add-On Acquisitions for Scalability

Add-ons are a powerful tool in competitive markets, providing firms with scalable growth without the hefty price tag of a full-scale platform acquisition, especially given Buy-and-build strategies have become the go-to for many firms looking to expand efficiently.

Dan shares:

“Add-ons let you grow with precision, and that’s where the real value lies.”

By targeting smaller, strategic add-ons, firms can scale existing platforms, achieving multiple arbitrage with each acquisition.

Building and Maintaining a Deal Flow Pipeline: How to Keep It Full

Maintaining a robust deal flow pipeline is essential for private equity firms to remain competitive. The pipeline isn't just about volume but also the quality and strategic fit of deals. Here’s a guide to building and sustaining a healthy deal flow pipeline, drawing insights from industry leaders and SourceCo’s proprietary approach.

1. Diversify Your Sourcing Channels

Many firms rely on the same 1-2 data providers, meaning they end up with the same information, the same percentage of the market, and the same companies as every other firm with their thesis.

Diversifying is therefore crucial, as Dan Kobayashi shared:

“Focusing only on brokers or databases limits your view of the market. Expanding your sourcing channels helps capture deals that others miss.”

Here are a few methods you can implement:

Combine Channels: Use a mix of brokers, direct outreach, and third-party networks. Create a calendar for outreach, attend industry events, and regularly engage with consultants to gain access to hidden opportunities.

Use Digital Platforms: Implement AI tools or deal sourcing platforms like Inven or SourceScrub for targeted lead identification. Set specific criteria within these platforms to automatically surface relevant companies, then export this data into your CRM for seamless follow-up.

Engage Consistently: Schedule follow-ups in your CRM, provide value through market insights, and nurture relationships with owners through non-transactional touchpoints.

Evaluate and Adjust: Regularly analyze which channels are producing the best leads. Use data to reallocate resources and experiment with new approaches like niche partnerships or specialized data providers.

Firms that diversify their sourcing approach—combining owner relationships, using deal sourcing firms, direct outreach, and tech-enabled searches—maintain a healthier and more varied pipeline.

2. Nurture Relationships Continuously

Relationship-building is a key pillar of maintaining healthy deal flow, as Tomos pointed out:

“Maintaining a pipeline is not just about finding new deals but about consistently engaging with the right people over time.”

At SourceCo, we use the below methods for relationship nurturing:

Regular Check-Ins

We Use a CRM to set reminders for periodic follow-ups with key contacts, schedule quarterly calls, share relevant market updates, and simply regularly reach out to touch base

Value

‍Our priority is to befriend and help business owners, sharing our expertise and experience along the way - this could be insights, such as benchmarking data or market reports, case studies - anything of value to our contacts and positions us as a trusted advisor, not just a potential buyer.

Hyper-personalize

‍Tailored communication based on the owner's or decision maker interests and business challenges is crucial for us, as it showcases our industry expertise and lets the owner know we're genuine. Then, we use information from past conversations to guide our next outreach.

We keep detailed notes of all interactions, allowing us to adjust based on feedback and engagement level to maintain a warm relationships over time.

3. Set Clear Criteria and Refine Them Regularly

Having clear criteria helps filter out deals that don’t align with your strategy. Tomos points out:

“Your criteria should reflect your strategic goals—don’t just chase every deal.”

Identify Key Metrics

‍The core metrics for deal flow include positive reply rates, meetings set, and deals closed. Each metric provides insight into different stages of the deal flow process, allowing firms to measure outreach success and refine strategies based on real-time performance.

Tailor Metrics to Your Investment Thesis

‍Not all searches are the same. For example, a PE firm focused on niche markets like municipal ice rinks will have different success metrics compared to one targeting high-volume commercial HVAC companies. Tomos added:

"When your Total Addressable Market (TAM) is small, invest more time and resources per target; when it’s large, streamline and scale efforts accordingly."

Therefore, it's imperative to align criteria with the unique market conditions of each search. (Eg, For niche searches, dedicate more resources and refine approaches regularly based on feedback).

Prioritize Fit Over Volume

‍It’s not just about the number of companies contacted; it's about quality and fit. Tomos explains,

“Positive reply rates are only meaningful when the responses are from companies that align with your strategic goals.”

Constantly refining your criteria helps avoid wasting resources on unfit prospects.

Use Data and Human Expertise to Refine Criteria

‍Combining human expertise with advanced data analysis allows firms to fine-tune their sourcing criteria continuously.

For example, in one of SourceCo’s campaigns, we adjusted criteria mid-search to better target companies with specific service mixes in HVAC, (in this case, the buyer's focus was HVAC with a specific service mix) leading to more high-quality deal opportunities.

Regularly Review and Adjust

‍Deal flow criteria should never be static. Regularly reviewing what works and what doesn’t, and adapting your approach accordingly, will ensure that your pipeline remains full of relevant, high-potential targets. As Tomos shared:

“Building a strong pipeline is about continuously learning and refining your approach.”

And added:

“Regular internal reviews help us adjust our tactics quickly, ensuring our sourcing is always aligned with real market dynamics.”

4. Maintain Agility in Your Deal Sourcing Approach

Agility is key to thriving in a dynamic market. Tomos Mughan emphasizes,

“We can’t stick to one approach; we have to constantly adjust based on what’s working.”

Here’s how:

Dynamic Resource Allocation and Scenario Planning

Shift resources weekly towards high-yield channels. For example, if direct outreach yields better responses, allocate more outreach team hours. Have contingency plans: in volatile sectors, set up “plan B” criteria to switch focus quickly if initial targets stall.

Continuous Feedback and Iterative Learning

Schedule bi-weekly debriefs with your sourcing team. Discuss metrics like response rates and adjust messaging or criteria immediately based on feedback. Use data to refine your criteria, so each iteration is tighter and more targeted.

Metrics and Tools to Use for Deal Flow Management

1. Essential Metrics to Track

• Positive Reply Rate: Measures the percentage of outreach efforts that get a positive response. If rates drop, tweak messaging, target sectors, or outreach channels. For example, if a particular industry shows low engagement, pivot to more receptive sectors.
• Time-to-Close: Track how long it takes from first contact to deal closure. Use this metric to identify bottlenecks, such as slow due diligence processes, and implement faster solutions like pre-vetted templates for commonly required documents.
• Deal Conversion Rate: This tells you how many sourced deals turn into acquisitions. If the rate is low, it might indicate the need for better qualification criteria upfront. Adjust by incorporating deeper financial analyses earlier in the process.
• Pipeline Velocity: Monitor the flow rate of deals through your pipeline. Stagnant deals can indicate a need to reallocate resources or adjust strategies. Tomos stresses,

“If velocity slows, reassess your team’s focus—don’t let deals sit idle.”

2. Tools for Enhanced Deal Flow Management

• AI-Driven Sourcing Platforms: Tools like SourceCo’s proprietary AI help scan vast data to identify potential targets based on precise criteria like industry trends, financials, and proprietary insights. This saves time by narrowing down to high-potential opportunities that match strategic goals.
• CRM Systems: Use CRMs like Salesforce or HubSpot to track all touchpoints with potential targets. Automate follow-ups and maintain a historical log of interactions. This allows for personalized outreach, which Tomos emphasizes is crucial for maintaining warm relationships.
• Analytics Tools: Implement predictive analytics to forecast which deals have the highest likelihood of success. These insights help prioritize resources effectively, focusing on targets with the greatest ROI potential.
• Feedback Systems: Utilize feedback loops within your CRM to collect input from deal teams on why certain deals progress or stall. We recommend setting up regular reviews of this feedback to refine criteria and sourcing approaches continuously.

Implementation Steps

1. Set Up Regular Metric Reviews: Schedule bi-weekly team meetings to review KPIs and adjust strategies. Use these sessions to dig into data, identify trends, and make quick adjustments based on performance.
2. Automate Data Collection and Reporting: Use your CRM to automatically pull data on key metrics, and set up dashboards that give you real-time insights into deal flow health.
3. Refine Criteria Based on Metrics: If positive reply rates or conversion rates dip, revisit your target criteria and refine them to better match market conditions or feedback from past interactions.
4. Align Tools and Teams: Ensure that all tools, from AI platforms to CRMs, are integrated to provide a seamless workflow from identification to acquisition. Regularly train your team on the latest features to maximize the value extracted from these technologies.

The Future of Deal Flow: Trends and Predictions

Here are key trends and predictions shaping the future of deal flow and sourcing, observed by SourceCo:

1. Increased Focus on Proprietary Sourcing

With high competition and elevated valuations, firms are pivoting towards proprietary sourcing to secure off-market deals.

According to PwC, bilateral deals are becoming a dominant strategy as firms look to gain an edge without facing competitive auctions. This trend is likely to grow, as firms seek greater control and negotiation power.

Prediction: Expect proprietary sourcing to expand, with firms dedicating more resources to building direct relationships and internal outreach capabilities.

2. Integration of Advanced Technology

AI and machine learning are set to play an even bigger role in deal sourcing. PitchBook highlights the growing reliance on AI for identifying patterns in market data, predicting deal success, and automating initial evaluations. These technologies help streamline the deal flow process, allowing firms to act faster and more strategically.

3. Greater Emphasis on Add-On Acquisitions

Add-ons are increasingly preferred as they offer a cost-effective way to scale existing platforms. This buy-and-build strategy is becoming the go-to for firms looking to create value through strategic bolt-ons, particularly in fragmented markets where smaller companies can be integrated at lower multiples.

We expect the number of add-on acquisitions to rise as firms seek scalable growth and value creation without the high costs associated with larger platform deals.

4. More Collaborative and Agile Deal Sourcing

In a rapidly changing market, agility is key. Firms will need to adopt more flexible sourcing models, combining internal resources with external partnerships. As Tomos notes:

“The future of deal sourcing is not just about having the right technology but also the right partnerships to pivot quickly when market conditions change.”

5. Evolving Regulatory and ESG Considerations

Regulatory pressures and growing emphasis on environmental, social, and governance (ESG) factors are reshaping deal sourcing criteria. Firms are increasingly factoring ESG risks and opportunities into their investment decisions, which impacts the types of deals they pursue.

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