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November 3, 2023

5 min read

PE Deal Origination in 2023: Webinar Key Insights

During our recent webinar “PE Deal Origination in 2023: Insights, Strategies, and Learnings,” industry experts, Natalie Yates from Vance Street Capital, Robert Young from Alantra, and Meahgan O’Grady Martin from Palladium Equity Partners, delved into the evolving landscape of private equity deal origination. 

They discussed the impact of increasing capital costs on deal multiples and the effective deployment of funds. The conversation also explored strategies for establishing business development teams, and the importance of discipline in avoiding bidding wars for top-tier assets. Below are some of the key insights from the session. If you’d like to listen to a full discussion, you can access it here.

What did 2023 look like in terms of deal activity? How's it evolving?

In terms of deal activity, 2023 has shown signs of improvement compared to the previous year. Meahgan highlighted that Q2 of 2023 saw an increase in M&A volume by 28% compared to Q1, and transaction value improved by 26%. However, there has been a significant decrease in sponsor exits, with buyout back exits down 54% on an annualized basis through Q2. Taking this into consideration, she highlighted the importance of having a diversified deal pipeline. 

“Luckily our deal pipeline is multi-tiered or multi-pronged…So we are never just depending on one source of deal activity to fill our pipeline…That means we're not just depending on the regular middle market investment banks to fill our pipeline…And so although our deal flow too was down a little bit year over year, even in the first half of the year, we were on average about flat to last year from a volume perspective.” - Meahgan O’Grady Martin

Robert noted that the tech sector at Alantra saw significant growth of around 50% year on year, in contrast to other sectors. The decrease in deal volumes was accompanied by a drop in valuations, particularly in the software sub-sector, where valuations hit a five-year low in the public markets. 

While middle market banks primarily focusing on sponsor-to-sponsor transactions have experienced a 40% decline in transaction volume year over year, according to Natalie, “The lower middle market is still holding in quite nicely because founders are not as susceptible to the market dynamics as a private equity firm would be.” 

Market efficiency has risen significantly, leading to a surge in the number of funds and intermediaries pursuing deals and founders. In this evolving landscape, the role of a dedicated business development person has become indispensable for maintaining competitiveness and ensuring the seamless flow of deals. 

Proprietary deals, which often require a long courting process of one to three years, or even up to five years, before the founder is ready to transact, now need the presence of a dedicated professional to nurture and maintain these relationships. By prioritizing business development, companies can differentiate themselves and ensure a steady flow of qualified leads, boosting deal margins and overall success.

What is the impact of technology and AI on deal origination? 

The use of AI for origination has become essential for private equity firms to stay competitive and keep their deal pipeline active. AI can help investors source deals more effectively, analyze vast amounts of data, and establish correlations and patterns to make more efficient investment decisions. 

Palladium Equity, as Meahgan stated, uses AI specifically for origination, allowing them to scale business development activities and have a large pipeline of potential proprietary opportunities even before closing a deal. This is particularly valuable for buy and build strategies, where quick acquisition and integration are crucial for growth and value creation. 

However, some firms, like Vance Street Capital, remain human intelligence focused due to the niche and specific nature of their business. While there are benefits to using AI for origination, it is important to note that there is still a heavy human element required for success.

“It’s taking our human network and then being able to track and map where those connections lie. So it's mining our operating network, our industry network for these specific connections to be able to get warm introductions.” - Natalie Yates

Although there is still a human element involved in the process, Robert uses data-driven AI tools that suggest origination targets, filter them by sub-sector and give suggestions based on multiple data points. While it’s still early days he can see how these tools will drive significant efficiencies and enhance origination activities. Robert also uses Arbolus and was sold on the platform due to its advanced features. 

“We’ve used it for a number of expert calls recently, in different sub-sectors and it’s just made that whole process so much more efficient. We haven't had to spend hours on calls sifting through transcripts. It's provided pretty neat summaries for us. Um, so we're definitely using it from an origination and a diligence perspective.” - Robert Young

How do you anticipate 2024 will play out? 

It is expected that deal activity in 2024 will continue to improve, but the change will be more gradual rather than a sudden tidal effect. The market has been craving stability after a volatile period, and both buyers and sellers need to feel confident in the value of the deals.

According to Natalie and Robert, the main themes for 2024 will be:  

  • The pressure on private equity funds to deploy their capital within fixed time cycles. With a record number of funds raised in previous years, funds need to catch up on deployment to continue raising funds in the future and provide returns to their limited partners. This pressure will likely drive increased activity in the coming months.
  • The increased competition for assets, particularly in the lower end of the market. The scarcity effect has led to funds going head-to-head on smaller deals, resulting in a shorter turnaround time for acquisitions. This increased competition is driven by funds coming down the market and bidding on smaller businesses, which were traditionally not in their focus.

Additionally, the webinar panelists mentioned challenges in fundraising due to limited dollars to deploy and a lack of capital returns. This logjam in the cycle is expected to continue into 2024, with limited changes in the macroeconomic environment and the potential impact of inflation on portfolio companies.

In our audience Q&A, our panelists covered the following questions:

  • How will the cost of capital impact sellers' ability to achieve the desired EBITDA multiples that they anticipated prior to the pandemic? 

  • There are still many PE funds that don’t have a dedicated business development function. As a mid-market firm with a more traditional approach to sourcing deals (investment bank CIMs):
    1. What could the first business development hire focus on to add the most value? 
    2. What are the potential pros and cons of outsourcing BD instead?
  • As Origination leaders in your organizations, how are you compensated or incentivized? Is it based on deals originated, deals closed, NDAs signed, or something else?
  • How does the cost of capital affect the ability of sellers to get the multiples on EBIDTA that they expected when they bought pre-pandemic?
  • With so much dry powder on the sidelines, at what stage do funds come under pressure to invest capital?

Watch the recording here to hear the full discussion and Q&A segment. 

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