In 2021, the private equity market was booming. The 3,895 exits totaling $665 billion in deal value broke records. In 2022, investors have hit the brakes.
The good news: thematic sourcing is a strategy private equity firms can rely on in high and low markets. It’s consistent and it’s on the rise.
In his recent column, Grata COO and Co-founder Nevin Raj wrote, “Less than 5% of PE firms are generalists. Compare that to 40% of PE firms that have true thesis-driven investment mandates.”
Globally, firms are still sitting on $3.4 trillion of dry powder, indicating a hyper-competitive landscape for deal making that makes it difficult for PE firms and investment banks to get a solid return on their invested capital. But it is also a huge opportunity for those looking to strengthen their thematic strategy.
There could be another issue contributing to so much uncommitted capital in the market: It’s not easy to find the best deals. To expand their investable universe, PE firms and banks need both a new approach and new technology. Thematic sourcing can uncover and close better deals.
PE firms and investment banks find targets in several ways.
These organizations tend to have a bias toward solutions that have been widely adopted throughout the industry, leading to very little variation in sourcing processes from organization to organization.
Firms and banks often use databases, such as Pitchbook, Preqin, and S&P Capital IQ, that provide private market financial and deal data for companies. Using the same filters (revenue, growth, industry, and location) in the same static lists, dealmakers using databases will see the exact same companies. The same can be said of conferences and industry events, where dealmakers are finding companies but also running into all of their peers.
In many cases, analyst and research teams will supplement technologies with their own Google and LinkedIn searches to identify companies and gather information on their size and growth, along with researching company websites and checking ownership and funding data on Pitchbook and Crunchbase. Some firms also may get leads from third-party intermediaries or bankers. All this information then flows into a massive spreadsheet or the organization’s customer relationship management system (CRM).
While this approach has worked for years for private equity firms and investment banks, it’s clear that traditional deal sourcing could benefit from a much more predictive approach, more automation, smarter search and analytics-driven insights.
To summarize, traditional sourcing strategies struggle to solve these two issues.
The answer: thematic sourcing. This means finding a niche and becoming a mini expert there. From there, dealmakers can jump to different adjacent niches until they find the right deal/s.
With thematic sourcing, or thematic investing, firms and investment banks formulate their sourcing strategy around a particular niche and/or long-term global trends that will reshape society.
What does this look like in action?
For TA Associates, their thesis-driven investment strategy starts with industry and size parameters. They are industry-focused: "investing in companies within five core sectors, offering deep domain experience and demonstrated success across business services, consumer, financial services, healthcare and technology industries." And they are looking at investments "ranging from $100-$600 million in equity and $10-$50 million in subordinated debt transactions that value businesses generally from $100 million - $3 billion."
Similarly, Serent Capital has committed to a multi-year investment thesis in the education sector. Education investments in fast-growing SaaS and tech-enabled service companies make up nearly 20% of Serent's portfolio, as of 2019.
Another thesis-driven firm is Compass Group Equity Partners. They describe their investment strategy as “proactive, not reactive” with a focus on "manufacturing & distribution" and "business & consumer services" with further specialization under those broad categories.
Thematic sourcing requires firms to be forward-looking. Think of it as gazing into a crystal ball in 1985 and forecasting the rise of the internet less than a decade later. Or predicting in 2010 that nearly every organization would need cloud-enabled technologies to support remote and hybrid work models in 2021.
More PE firms and investment banks should seek to deepen their industry knowledge. To visualize this strategy: a shallow, wide net in an ocean doesn't catch any fish but many deep nets in many lakes will catch the best fish.
Another way to become an expert is via similar company searching. Firms can identify the deals lost (but that completed some level of diligence along the way) and find related companies. This can help firms uncover prospects their competitors would have a hard time finding and potentially saving them considerable time from sourcing to closing the deal.
With this approach, firms can focus on a particular theme, niche or industry and become an expert in it — whether it’s focusing on hypergrowth professional service and accounting firms in the middle-market or women-led artificial intelligence companies with under $20 million in revenue. Thematic sourcing allows firms to really specialize to find the right companies that align with their unique investment criteria.
However, firms still need technology to enable this sourcing strategy.
After defining a thesis, the next step is to start searching. There are a few ways to go about running a thematic search.
The private equity market likely has never been more competitive. At the same time, there are millions of growing companies ripe for investment. However, PE firms and investment banks won’t be able to discover them without a modern, technology-enabled deal sourcing strategy. By embracing thematic sourcing and leveraging a private company intelligence engine, these organizations can become specialized generalists, fill their pipeline with truly differentiated companies, and accelerate the deal lifecycle.
Grata’s optimizes the data-gathering processes and drives thematic sourcing for PE firms and banks. Organizations can use the platform to search for target companies based on company size, industry or specific keywords, such as “customer success software,” “organic baby products” or “warehouse automation.” Then they can build targeted lists of companies to support their thematic campaigns.
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