— 10 min read

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

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

In this article, we will demystify the world of deal sourcing, exploring its definitions, importance, and various types and strategies.

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. 

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.

What Is Deal Sourcing?

Deal sourcing, also known as deal origination, refers to the process of identifying and analyzing potential business opportunities or transactions. As a term, it is commonly used in private equity and venture capital, where there are various methods used in order to source deals. Common avenues to deals are referrals, conferences, databases, and more recently data-driven technology that equips dealmakers with up-to-date company information. 

In its true essence, deal sourcing aims to ensure that the business acquires various deals throughout a set period to keep a viable deal flow. PE firms, investment banks, and types of capital allocators need a constant stream of deals to achieve their goals - and deal sourcing is the first step.

Once a deal is sourced, meaning there’s initial interest from the company to do a deal, the firm will move on to the next step of due diligence.

Why Is Deal Sourcing Important?

With the current state of the market, companies are under pressure to find and transact with promising companies in order to stay competitive. This has led to an increase in pressure and competition in deal cycles.

Additionally, the rise of new businesses that can start and grow successfully with lower capital has made the process of deal sourcing even more critical for companies.

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

With the new normal, firms need to take control of their own deal flow by building direct sourcing teams and processes. The aftermath of COVID-19 has further highlighted the importance of being nimble and able to quickly modify where and how firms source deals.

To compete, firms must identify and build relationships with the right targets earlier in a company's life cycle. 

How Does Deal Sourcing Work?

At its core, deal sourcing or deal origination is relatively simple. It's about:

  1. Identifying new deal opportunities
  2. Pitching those deals
  3. Managing and maintaining relationships and reputation

The key is to have a clear understanding of your firm's mandate and target markets.

With this information, you can then identify potential deals that align with your objectives and begin to engage with the relevant parties.

Deal Sourcing Steps

Assemble A Deal Sourcing Team

The first step in deal sourcing is to assemble a team of individuals who will be responsible for identifying, evaluating, and engaging potential deals. This team should include individuals with expertise in market research, industry analysis, and networking.

Choose Your Deal Sourcing Strategy

After assembling a team, the next step in deal sourcing is to select a method for identifying potential deals. This could include traditional deal sourcing methods such as networking, industry analysis, or discovering opportunities in M&A platforms.

It is important to choose a method that aligns with the company's strategic objectives and investment criteria and that the team has the tools they need to execute effectively.

Make A List Of Prospects (Target List)

Once a strategy has been selected, the team will begin to create a list of potential acquisition targets, partners, and investment opportunities.

This list, also known as the target list, should be regularly updated and reviewed to ensure that it aligns with the company's strategic objectives and investment criteria.

Conduct Initial Outreach

You can only gather so much relevant information about targets from the outside in. Eventually, you will need to reach out to decision maker to learn more about their business. If the business owner responds to your request to learn more, you will move toward the due diligence process: analyzing financials and assessing the potential risks and benefits of the opportunity.

What Are The Types Of Deal Sourcing?

Traditional Deal Sourcing Or Network-Based Deal Sourcing

Traditional deal sourcing, also known as network-based deal sourcing, involves identifying potential deals through personal connections and industry networking.

This can include attending industry events, networking with other industry professionals, and leveraging existing relationships to identify potential deals.

This type of deal sourcing relies heavily on the professional's personal network and reputation.

Traditional Deal Sourcing vs Proprietary Deal Sourcing

A proprietary deal can take one of two forms: 1) a deal in which a firm is the only bidder or 2) a deal in which a firm is the first of multiple bidders and has a significant head start in terms of a relationship and access to company information. Proprietary deal sourcing requires dealmakers to incorporate technology and data analysis to identify potential deals.

This can include using online databases and platforms, data analytics tools, and other digital resources to identify and evaluate potential deals.

This type of deal sourcing allows you to reach a larger number of potential deals and analyze data on a much larger scale. It also enables you to track the progress of a deal and make better predictions as to the 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

Nowadays, driven by data services give visibility into historically opaque private markets. Firms that don't embrace new techniques are quickly being surpassed by their peers.

Who Utilizes Deal Sourcing

Deal sourcing is a common practice in the worlds of venture capital, private equity, investment banking, and mergers and acquisitions.

VC Firms

Venture capital firms rely heavily on deal sourcing to identify and invest in promising start-ups and early-stage companies. They use deal sourcing to identify potential companies that align with their investment criteria and that have the potential for significant growth.

Investment Bankers

Investment bankers use deal sourcing to identify potential acquisition targets and to source potential buyers for companies that are looking to sell. They use deal sourcing to find the best fit for the company's requirements, whether it is a merger or an acquisition.

Private Equity Firms

Private equity firms use deal sourcing to identify and invest in undervalued or underperforming companies that they believe have the potential for significant growth. They use deal sourcing to find potential investment opportunities, evaluate them and then invest in them.

Corporate M&A

M&A teams in corporations use deal sourcing to identify potential acquisition targets, evaluate them, and then negotiate the deal. They use deal sourcing to find potential companies that align with their goals and that can be integrated into their company.

Best Practices For More Promising Investments And Acquisitions

Take Advantage Of Private Market Intelligence

Using a platform like Grata, you can develop a deep understanding not just of a potential deal, but also of the whole industry and market as a whole.

This involves researching the specific industry and market you are interested in, including identifying key players, trends, and potential opportunities… But, it also involves looking at broader economic and industry trends that may impact your investment strategy.

Correctly Assess The Opportunity

Another important aspect is to study past exits and acquisitions of similar companies, to better understand the potential outcome of an investment.

Something that looks like a good deal on paper might not be good enough, simply because there is not enough evidence of successful exits in the past.

On the same note, you need to compare different companies within the same market or industry to identify the most promising opportunities. By evaluating similar companies side-by-side you can get a much stronger understanding of the differences (and similarities) that make a deal desirable.

And finally, don’t forget:

Numbers (usually) don’t lie.

Take The Timing Into Account

This is all about identifying companies that are in a position to receive funding or be acquired, based on their current stage of development and growth.

There is always a golden window for acquiring a stake in a company. It’s easy to understand what being late looks like, but it is also possible to be too early.

Frequently Asked Deal Sourcing Questions

How does private equity deal sourcing work?

At the heart of private equity deal sourcing, firms are constantly on the lookout for potential investments that align with their strategic objectives.

This could involve utilizing a dedicated in-house team, bringing on experienced professionals, or utilizing specialized deal sourcing platforms to identify opportunities.

Once potential investments are identified, the team will conduct extensive research and outreach to thoroughly evaluate the opportunity and pave the way for successful deal-making.

What is deal execution?

Once potential deals have been identified through sourcing, deal execution involves the nitty-gritty work of fleshing out the details and finalizing the transaction. This includes tasks such as building financial models, evaluating exit potential, and navigating the legal and financial complexities of the deal itself.

How long does a PE 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 in private equity 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 LPs (limited partners), 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 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 online platforms and tools to identify and evaluate potential startups, which can be especially beneficial for newer firms that may not have as established networks.

How do VCs do research?

Venture capitalists conduct research, also known as due diligence, to thoroughly evaluate the potential of a startup before making an investment. Given the significant equity stake involved in venture capital deals, and the fact that venture capitalists invest in early-stage companies, it is crucial that they carefully consider all aspects of the startup. This 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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