Why PE Firms Need to Invest Early as an Effective Deal Origination Strategy

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The Financial Times warns that the market is more cutthroat than ever, stating, “It is an indicator of the heated conditions in private equity that buyout organizations are establishing new records for fundraising and rejecting cash away at their fastest rate ever.”

Total assets under administration increased 9.6% from the end of December 2016 to a new high of $2.83 billion in June 2017. This was more than twice the industry’s size in 2006. With dry powder levels approaching $1 trillion and greater competition from direct investors, we should expect high valuations to persist.

Competition is also fostered by direct investment from sovereign wealth funds and family offices. This puts more pressure on investors to locate high-quality investment possibilities with acceptable rates of return.

Increasing complexity

As a percentage of significant worldwide PE agreements, the number of private equity “secondary” deals (and “tertiary,” and so on) has increased. The complexity is growing, necessitating the ability to dig down from a sector level to the intricacies of each origination opportunity through subsectors.

 

Business acquirers with M&A-driven growth strategies are also vying for the best assets. Because of their excellent balance sheets, they are becoming more active, actively pursuing more efficient use of cash balances, strong leverage markets, and historically high share prices.

 

Corporates are willing to pay higher multiples for premium assets than they would have been in the past, thanks to technological innovation and corporations’ increased ability to extract deal synergies, allowing them to outbid private equity houses in auction procedures.

Unilever, the world’s largest consumer goods company, is a prime example. “The mergers and acquisitions department of the Anglo-Dutch company that manufactures Dove soap and Magnum ice cream has been so active in the past three years that it would require bags to cram samples from all these deals,” according to The Financial Times. Sundial Brands, a specialty skincare company, has been acquired, while Flora and Stork, two old standbys, have been divested.

In this context, private equity firms must identify opportunities with a strong transactional advantage — narrowing in on corporate disposals and vying for them in acquisitions — before the general market does.

Origination capability

It’s becoming exceedingly challenging for fund managers to locate proprietary transactions with low entry costs and little competition. Pricing at the point of entry is still one of the most crucial variables in the success of an investment, with 62 percent of private equity fund managers seeing valuations as their largest difficulty.

Executives have responded by sourcing deals more effectively and creating relationships early in the transaction life cycle. It was not uncommon a decade ago for private equity firms to participate in auctions where receiving the “teaser” was the first time the firm had ever examined an asset.

This is no longer the case, as a clear link between the number of resources invested at the origination and the rate of return has emerged. Private equity and venture capital funds that adopt a proactive origination strategy consistently generate superior returns, fueled by both bigger quantity and higher relevance of inbound investment possibilities.

How Shikana Group can help

Origination includes finding exclusive transactions and uncovering aspects that can provide a house with an advantage in its appraisal or business plan execution in competitive scenarios. The origination tactics used by funds range from primarily in-house to adviser-led strategies.

Shikana Group has knowledgeable advisors to address and support the growing number of non-core carve-outs resulting from the abovementioned industry dynamics. We work closely with our clients to help them source, scrutinize, arrange, and manage deal and acquisition prospects, such as:

  • Target identification and screening
  • Deal origination strategy and negotiation

For further information on what we do, please contact us or visit our website.

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