— 10 min read

If you operate in the worlds of venture capital or private equity, or if you deal with mergers and acquisitions, deal sourcing is one of the most important skills you need to cultivate.

David Paul, CEO and a Managing Director at DWP Capital, says, “Anybody can write a check. Everyone wants to get that founder high. Where the rubber meets the road is sourcing.”

Deal sourcing is the process of finding companies to invest in. Traditional deal sourcing strategies involved referrals (word of mouth), networking, and attending conferences. However, increased competition has forced firms to evolve. 

In this article, we demystify the world of deal sourcing, including what it means, why it’s important, and its various types and strategies.

Read on to discover how market data can help you develop a successful investment strategy, identify companies in your desired industry that are ready for funding or acquisition, and accurately assess a company's potential for growth.

Introduction to Deal Sourcing

What Is Deal Sourcing?

Deal sourcing refers to the process of identifying and analyzing potential business opportunities or transactions. 

Private equity (PE) and venture capital (VC) firms need a constant stream of deals to achieve their goals. The goal of the deal sourcing process is to ensure that firms evaluate enough potential opportunities in a given time period to create a viable deal flow . 

PE and VC firms both leverage various methods to source deals, including:

  • Referrals that connect dealmakers with targets via personal or business contacts
  • Databases that enable investors to store and track information about potential targets
  • Tech platforms that equip dealmakers with dynamic data and workflow tools

Once a deal is sourced—meaning the target company is interested in making a deal—the firm will move on to the due diligence phase.

The Importance of Deal Sourcing in Private Equity and Venture Capital

Private equity and venture capital firms need to find and transact with promising companies to stay competitive—especially with the current state of the market. That means efficient deal sourcing is more important than ever.

New businesses are increasingly able to start and grow successfully with less capital, making the deal sourcing process even more critical for private equity and venture capital companies.

The days when companies could rely solely on intermediaries to provide them with an adequate deal flow are gone.

Additionally, the COVID-19 pandemic and its aftermath of COVID-19 have underscored the importance of agility and adaptability in the deal sourcing process.

Private equity and venture capital firms have to take control of their own deal flow by building direct sourcing teams and processes. Firms must also identify and build relationships with the right targets earlier in their life cycle. 

Deal Sourcing Strategies

Strategies for Private Equity Firms

The two main private equity deal sourcing strategies are:

  • Traditional deal sourcing (also called network-based sourcing)
  • Proprietary deal sourcing

Through traditional deal sourcing, or network-based sourcing, PE firms identify potential deals through personal connections, business networking, and attending industry events. 

While traditional deal sourcing relies heavily on a professional’s personal network and reputation, proprietary deal sourcing incorporates technology and data analysis to identify potential deals.

Proprietary deal sourcing can involve using online databases, software platforms (like Grata), data analytics tools, and other digital resources to identify and evaluate potential deal targets. 

Solutions that empower investors with unique data and AI-powered workflows provide visibility into historically opaque private markets. To stay competitive, private equity firms need to embrace these new technologies.

These deal sourcing tools allow private equity firms to reach a larger number of potential deals and analyze internal and third party data on a much larger scale. They also provide tracking tools to manage the deal pipeline and workflows that improve the probability of achieving the desired outcome.

Proprietary sourcing improves returns by 10-20% and yields $13M more carry per deal for the average middle market deal of $150M and 19% IRR.

1. Datafrom CEPRES.Sample includes 107,000 PE-backed companies and 11,000 funds 

2.PitchbookData: Q32021 US PE Middle Market Report

Strategies for Venture Capital Firms

Deal sourcing is crucial for venture capitalists, as the standard conversion rate from first meeting to investment typically falls below 1%, according to 4Degrees.

The VC deal sourcing process focuses on identifying and investing in promising start-ups that align with their investment criteria and have the potential for significant growth.

Venture capital firms use slightly different deal sourcing tactics than private equity firms, including:

  • Establishing quality networks with various industry stakeholders, including entrepreneurs, investors, and other VC companies
  • Working with incubators and accelerators to tap into groups of startups that have already been vetted
  • Participating in startup events, such as pitch competitions and demo days

Platforms and Tools for Deal Sourcing

Leading Platforms for Private Equity and Venture Capital

Many private equity and venture capital firms rely on deal sourcing tech platforms to find and connect with investment targets. 

For example, Grata’s AI-powered deal sourcing solution enables users to tailor their company search with purpose-built filters, including software classifications, revenue, ownership, funding, and more. The Similar Companies tool uses AI to identify themes and suggest other relevant companies, helping users find a broader pool of potential targets.   

From there, Ana, Grata’s AI analyst, helps dealmakers perform desktop diligence to determine if a possible target should be contacted. If the answer is yes, Grata’s platform provides up-to-date, verified contact information for company executives.

Customer relationship management (CRM) platforms like HubSpot, Salesforce, and DealCloud supplement the deal sourcing workflow by housing proprietary data. They allow PE and VC companies to track their interactions with clients and prospects as they move down the funnel, and they may even integrate with deal sourcing tools to enable new workflows that generate deals.

The best deal sourcing platforms integrate with CRMs to make the process of finding and tracking deal targets as efficient as possible. Grata users can enhance their deal sourcing efforts by filtering searches and lists in the Grata platform with CRM data so that they can seamlessly pinpoint key relationships and top-scored deal targets.

To see firsthand how Grata can help you optimize the deal sourcing process, schedule a demo here.

Best Practices in Deal Sourcing

Private Equity Deal Sourcing Best Practices

To find the most promising investment and acquisition opportunities during deal sourcing, private equity firms should follow these steps:

  • Invest in your sourcing strategy. A strong strategy incorporates both technology and internal employees. Assemble a team of individuals who will be responsible for identifying, evaluating, and engaging potential deals. These individuals should have expertise in market research, industry analysis, and networking to get the most out of a deal sourcing tech platform.
  • Harness your proprietary data. Supercharge your CRM usage. With Grata’s CRM Intel, users can leverage their firm’s proprietary data from Salesforce, DealCloud, or HubSpot to uncover more deal targets. Users can access their CRM data directly in the Grata platform so they can identify top-scored deal targets and focus on cultivating the most promising opportunities.
  • Nurture the dealmaking ecosystem. Find a way to be top of mind with bankers and service providers like consultants, lawyers, and accountants. With Grata’s platform, investors can search for and connect with intermediaries and advisory services. Grata’s CRM integration also makes it easy to build, track, and nurture new relationships.

Venture Capital Deal Sourcing Tactics

VC firms can get the most out of their deal sourcing process by:

  • Build relationships with founders early on. Timing is a crucial component of dealmaking. As an investor, you always want to be the first one at the party. Connect with founders and establish a genuine rapport with them as early in the company lifecycle as possible.
  • Use conferences to facilitate in-person interactions. While the world may seem to only be getting more digital, face-to-face meetings are still hugely important when it comes to the deal sourcing process. Grata’s Conferences & Events lets users find events in their industry and prioritize attendee lists so they can book more meetings and source better deals.
  • If you’re investing in software, strengthen your ability to identify and segment specific verticals. Investors can miss opportunities if their search is too broad. This is especially true in the software sector, where niches are infinite. AI-powered search tools—like Grata’s—can help go deeper in their searches and discover more relevant prospects.

Case Studies and Examples

Successful Deal Sourcing in Private Equity

One example of a private equity firm successfully utilizing deal sourcing is LFM Capital, a PE firm focused on small North American manufacturing businesses. LFM Capital chose to partner with Grata because of Grata’s user-friendly interface and highly specified search capabilities.

Using Grata’s AI-powered search, LFM Capital was able to identify potential investment opportunities with unprecedented precision. Ryan Richardson, a Senior Associate at the firm, described the experience of using Grata to source deals in the defense electronics industry: 

"We were able to narrow a pretty impressive list of add-ons of about 250 or so companies in the U.S. and Canada that met a lot of key investment criteria for us." 

Richardson also praised Grata’s ability to parse companies’ information even from less up-to-date websites, appreciating the system's ability to "scan an entire website, every single page of it, and identify certain vocabulary, terminology, services, capabilities, and acronyms specific to this industry.”

LFM Capital’s portfolio companies also leveraged Grata’s data and search capabilities to bolster business development efforts.

See more case studies exemplifying how Grata has helped private equity firms optimize their deal sourcing process here

Challenges in Deal Sourcing

Overcoming Common Challenges

Some of the deal sourcing challenges most frequently faced by private equity and venture capital firms include:

  • Intense competition. In today’s challenging market, PE and VC companies are all vying for the most attractive investment and acquisition opportunities. Differentiating yourself is crucial for capitalizing on deal opportunities. You should know everything about the market and your competitors before reaching out to prospects. Platforms like Grata leverage advanced natural language processing (NLP) and machine learning (ML) to provide contextual insights about private companies so that investors can sharpen their competitive edge.
  • Effective deal screening. The sheer volume of companies in a given space presents a huge challenge. Investors can’t waste time pursuing targets that aren’t a good fit. Advanced, tech-driven desktop diligence methods ensure that investors are only going after the right prospects. For example, Grata’s AI analyst, Ana, allows investors to screen deals with precision and gain a deeper understanding of the market landscape.
  • Establishing consistent deal flow. Limited access to potential targets can hamstring the investment process and hinder growth. Investors need an efficient pipeline management tool to keep their teams aligned. With the My Pipeline feature on Grata’s platform, users can track their funnel, take notes on interactions, set custom labels for prospects, and more. Paired with CRM Intel, the Pipeline tool streamlines the deal sourcing workflow so that investor teams can efficiently find the best opportunities.   

Strategic Approaches to Enhance Deal Flow

The best way for PE and VC companies to overcome these hurdles and get the most out of their deal sourcing process is to find and effectively utilize the right tech-based, data-driven solutions.

These tools provide investors with insights into specific companies as well as a broader understanding of market trends, which can improve strategic deal sourcing and deal flow.

The Future of Deal Sourcing

As technology continues to evolve, it creates new ways to source deals and streamline the vetting process for private equity and venture capital firms. 

In the next several years, investors should watch for the future of deal sourcing to be shaped by AI and advanced data analytics. Advanced data analytics will help PE and VC companies identify industry trends as well as promising investment and acquisition opportunities. Additionally, AI-powered tools will increasingly assist with screening and evaluating potential deal targets.

Learn more about how Grata leverages quality data and AI to help investors optimize their deal sourcing methods here.

Frequently Asked Questions (FAQs)

Common Questions About Deal Sourcing

What is deal execution?

Once potential deals have been identified through sourcing, deal execution involves fleshing out the details and finalizing the transaction. This includes building financial models, evaluating exit potential, and navigating the legal and financial complexities of the deal.

What is deal flow?

Deal flow refers to the number of investment opportunities available to an investor at any given time.

How long does a private equity deal take?

The length of a PE deal can vary greatly depending on the complexity of the transaction and the parties involved. The process can take several months to conduct due diligence, negotiate, and finalize the valuation and the purchase agreement.

What is due diligence in private equity?

Due diligence in private equity refers to the comprehensive examination and analysis of a potential investment opportunity by a private equity firm. This process includes evaluating factors such as a company's financial performance, market position, potential value, and potential risks and opportunities. It is a crucial step in the investment decision-making process for private equity firms.

What is dry powder in private equity?

Dry powder refers to the amount of uninvested capital that a private equity firm has available for future investments. It is the money that has been raised and committed by limited partners (LPs), but has not yet been allocated to specific deals or opportunities. It is considered a strategic reserve, allowing a private equity firm the flexibility to capitalize on new opportunities as they arise.

What is deal structuring?

Deal structuring refers to the process of negotiating and determining the terms and details of a merger, acquisition, or other business transaction between two parties. It includes negotiations around the type of deal, such as an asset acquisition, stock purchase, or complete merger, as well as the specific terms and conditions that will govern the transaction. The process may involve several stages of negotiation and the preparation of various legal documents to finalize the deal.

How do VC deals work?

In a venture capital deal, a venture capital firm invests funds they have raised from limited partners into an emerging company in exchange for an equity stake in the company. The VC firm then works closely with the startup to help it grow and scale, with the goal of exiting the investment at a later stage through an IPO or a sale of the company. Once the company is successful and reaches a desired valuation, the venture capital firm will sell its shares for a profit, providing a return on investment to its limited partners.

How do you source a startup in VC?

Sourcing potential startups for venture capital investment can be achieved through a combination of building a strong network and utilizing data platforms. Traditional methods of sourcing deals include networking and building relationships with industry players and entrepreneurs. Additionally, many venture capital firms are now utilizing sourcing platforms and tools to identify and evaluate potential startups, which can be especially beneficial for newer firms that may have less established networks.

How do VCs do research?

The venture capital research process, or due diligence, includes evaluating the company's founders, industry, market conditions, and other relevant factors to assess the startup's potential for success.

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