Private equity firms need to get creative with deal sourcing amid coronavirus – and here’s how

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Deal sourcing intelligence business Sutton Place Strategies explains how private equity firms can get strategic, efficient, and creative with their deal sourcing in the teeth of the coronavirus crisis.

It’s amazing how much can change in a year. In the 2019 edition of The Science of Deal Sourcing 101 titled “Recession-proofing your deal sourcing strategy”, there was an emphasis on measures PE firms can take to adapt and thrive in an economic downturn. While many had been predicting a recession given the prior decade of economic expansion, no one could have guessed that the catalyst to set it off would be something powerful enough to bring the whole world to its knees, yet invisible to the naked eye.

Despite living in the information age, with both technology and data advancing at unprecedented rates, one thing Covid-19 has taught us is how little we know and how crippling uncertainty can be. More than ever, we’re turning to information to quell our fears, forecast our businesses, and plan like never before.

If you’re one of the PE firms that considers deal sourcing vital to your success and fund performance, then you’ve likely developed a tech-enabled, data-driven origination approach, directed by top-caliber professionals building lasting relationships. In which case, congratulations, you’re no doubt well-poised to take advantage of the great investment opportunities that post-recessionary environments create. If you hadn’t, don’t despair, there’s still hope.

So what does the data tell us? The steady rise of median PE quarterly deal flow seems to have reached its cyclical peak in Q1 2019. Due partially to the perennial beginning of year spike in launched processes, quarterly deal flow has declined gradually for the last three quarters, and Q1 2020 was down slightly compared to Q1 2019. The quarterly comparison, however, may not paint an accurate picture, since the impact of Covid-19 didn’t hit North America and Europe until March. When we look at monthly deal flow, January and February were both flat year over year, but March was down approx. 35%, a trend that will spill over to subsequent months. Expect Q2 2020 numbers to lag by 40-50% year-over-year.

Recessions have historically had another significant effect, which is stretching out the length of time it takes to close a deal. When we look at closing rates since 2014, even as deal flow rose steadily, the percentage of deals coming to market that ended up closing consistently hovered in the 35%-42% range. Many processes that were launched in early 2020 were put on pause given the uncertainty in the market. While some will resume and ultimately close, others will stall permanently. As a result, in addition to a significant drop in median quarterly deal volume, we expect deal closing percentages to also decline, to levels conceivably lower than we’ve ever seen.

There are key takeaways from these trends that all private equity firms can use to help guide their sourcing strategy. Perhaps most immediately, as deals that were launched in early 2020 either close or go stale, an automated method to identify broken processes at potentially lower multiples is vital.

In the absence of travel and low deal flow, there are many additional ways PE firms can get strategic, efficient, and creative with their deal sourcing. These include updating intermediary tiering while accounting for new relevant firms, keeping contact data current through a CRM plug-in, and refreshing distressed and restructuring advisor lists. Taking the time to do some Spring and Summer cleaning and getting organized now will reap great benefits once travel and conferences pick up again.

While it will likely take some time for deal activity to return to 2019 levels, there is no dearth of capital needing to be put to work. With fewer deals, the supply-demand mismatch opens the door for imaginative and forward-thinking deal originators willing to embrace a shifting M&A landscape. Having cleaner, current internal data, as well as leveraging analytics and automation, will create efficiencies and expose alternative sourcing channels that the competition lacks. The next year or two may well be the best investment vintages in the next decade, and those that find a way to get deals done will be rewarded.

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