Treasure hunt: striking the right origination mix

Where the next deal is going to come from is a growing concern for many GPs, with dry powder mounting, despite record buyout numbers in 2017 and 2018. A majority (72%) of respondents polled in a 2018 PwC report named scarcity of investment opportunities as a top-three challenge.

With a far larger number of potential targets to review than their private equity counterparts, many venture firms have been looking to technology to enhance their deal sourcing. Some have built proprietary software to flag companies that are likely to succeed based on early analytics.

Origination platforms normally trawl through social media reviews, app ratings and funding history, and analyse the data to prioritise and find companies that VC firms have not discovered through their personal network. Some platforms employ artificial intelligence and machine learning, and most leverage big data.

Olof Hernell, chief digital officer at EQT, started Motherbrain at EQT Ventures around four years ago. When the team created the software, it gave itself three milestones: to source a critical mass of deals the team could invest in; to make an investment in a Motherbrain-sourced company; and to make an exit from that pool. Says Hernell: "It took us six to nine months to reach the first milestone. EQT has now invested in five Motherbrain-sourced companies and over time the exits will come."

One of the five investments is Anydesk, which sells remote working software. The firm led a €6.5m series-A funding round in May 2018. Interestingly, the company was not looking for seed funding when EQT Ventures first contacted the team.

Hernell emphasises the impact the software has had on the investment team: "Motherbrain is not just the pure sourcing machine it initially started as. Over time, it has become a more analysis-focused machine, which prioritises and records our decisions, assessments and knowledge."

Another venture firm that is building similar software is Project A. The firm's operational team of around 100 developers and analysts built its proprietary software based on the recommendations of the investment team. Meanwhile, London-based InReach Ventures and US-based SignalFire use machine learning and artificial intelligence, respectively, in their proprietary software.

France-based Ardian has also built its own origination platform. Although it has now been extended for use across the firm, digital experiments began in Ardian Growth. Ardian Growth II, which closed on €230m in 2018, is one of Ardian's smaller funds and provides equity tickets in the €5-25m range to digital businesses with a turnover of €5-100m. The division's proprietary software, Redpoint, is based on a database that was started around 15 years ago. The system accepts structured data – such as data from deal-making databases and niche markets databases – as well as unstructured data from the internet, social networks and online interactions that Ardian has with other companies. It then consolidates both types and can analyse that data in real time. The groundwork seems to have paid off, as Ardian Growth says that 90% of its investments and bolt-ons are now identified through Redpoint.

Over time, Motherbrain has become a more analysis-focused machine, which prioritises and records our decisions, assessments and knowledge" – Olof Hernell, EQT Ventures

Old school
Origination software fits well with the requirements of venture, but has not been adopted with as much enthusiasm in the private equity sphere.

While EQT uses Motherbrain across the firm, the buyout team has yet to make an investment sourced by the software. "It is a different case at buyout level," says Hernell. "Very rarely we see companies that no one has seen or is talking about. Our professionals know the market very well, so it is more about being data driven in our assessments."

The situation is the same at Ardian. Although not strictly a venture team, Ardian Growth targets a smaller deal bracket than the firm's other funds. When asked why the software was built in his team, Ardian Growth head and managing director Laurant Foata says: "We have more than 20 years of experience in the software landscape, so we are used to seeing the value of it."

Software and internet investments have made up 48% of early-stage and growth investments, and only around 9% of all private equity investments over the past five years, according to Unquote Data. Venture investors could spend their entire careers reviewing new technology and analysing its benefits, so might naturally imagine the effects on their own productivity.

Venture firms are also more likely to hire technology experts rather than the investment professionals filling private equity firms. When asked why Motherbrain was implemented at EQT Ventures first, Hernell says: "EQT Ventures was a first-time fund, so we were starting with a blank page and an already tech-focused team. EQT hired people from companies such as Spotify, Google, Palantir and Oracle, so this type of innovation was in their DNA."

3i France managing director and partner Remi Carnimolla also makes the point that the technology may not function well for all sectors: "If you buy a consumer business, social media listening is very important because you need to get to know that brand. When it comes to a more industrial business, digital tools are a bit less relevant." Seeing that the industrials sector has been home to 37% of European buyouts over the past five years, according to Unquote Data, firms that mainly focus on the segment could be understandably reluctant to implement potentially ineffective and costly software.

Face-to-face focus
Many fund managers believe relationship building is still vital to the process. In markets where deals are mainly acquired from families or private owners, management teams continue to expect face-to-face interactions with their investors. Says Investec director Kai Stengel: "Even with larger deals in Germany, relationships are still very much valued. For example, you have to attend the site. They like to know who you are." Almost 60% of buyouts recorded by Unquote in the DACH region in 2018 were sourced from private or family vendors.

That number rises to 71% in Italy and Iberia, with SBOs accounting for just 22% of deals. Alantra Private Equity partner David Santos, based in the firm's Madrid office, says: "Our team largely focuses on identifying off-market transactions in the mid-market, where trust between business owners and our team plays a crucial role in the success of the project." Like many GPs, the firm does not have a dedicated deal-sourcing team; instead, the team member that focuses on origination stays with the company until divestment.

The reluctance to fully adopt new origination technologies in markets with smaller private equity penetration makes sense, as GPs are better able to leverage their personal connections and market knowledge. But even in a region with fewer family-owned businesses on the market, and therefore a smaller likelihood of completing a proprietary transaction, face-to-face contact is still important to GPs.

In 2018, 44% of French buyouts were secondary deals, the highest proportion seen by Unquote across Europe. 3i France's Carnimolla says he often attends trade shows, as it is a good way to engage with managers. He also stresses the need for advisers with strong personal networks. "Technology will never replace the need for relationship building," he says. 3i recently made an investment in IT company Evernex following deep sector research by the firm's investment professionals. Carnimolla met the managers at a sector trade show and, after following the company for more than two years, 3i acquired a majority stake in July 2019.

If you buy a consumer business, social media listening is very important. When it comes to a more industrial business, digital tools are less relevant" – Remi Carnimolla, 3i

The fact that GPs continue to open new offices in the regions in which they are investing is emblematic of this philosophy. Since the beginning of 2019, Unquote has reported on seven firms opening regional offices in Europe. Alantra's Santos says: "A domestic footprint allows us to create and maintain solid relationships with companies' owners, executives, local advisers, banks and institutions, fuelling deal origination and creating bilateral discussions with potential targets."

EQT's Hernell agrees: "If you look at EQT's digital business development teams, you will see they use very local networks." EQT, which touts its "locals-with-locals" approach, opened a Milan office in July.

In addition, some GPs are forming alliances to expand their networks and gain a local presence without necessarily opening an office. Capiton, which is a part of the Global PE Alliance, along with FSN Capital and Livingbridge, acquired Hamm Reno in 2016 off the back of its relationship with Turkish partner fund Turkven. In 2018, Tikehau Capital and asset manager DWS announced a strategic alliance to share origination efforts by offering one another co-investment opportunities. H2 Equity Partners, Sherpa Capital and Auctus Capital Partners formed the Optimum Alliance in June 2019 to offer deal origination resources and co-investment opportunities.

This is not to say that firms will not continue to use some form of technology in the deal-making process: 97% of GPs made investments in digitally transforming their own firm or portfolio company business models in 2018, according to a PwC survey conducted by Unquote sister company Acuris Studios.

For example, 3i operates a database populated with all the companies owned by GPs and VCs in France. Once the investment professionals decide on companies they are interested in, they enrich the database with all the discussions they have with managers and advisers, and the knowledge they gain from research. Carnimolla tells Unquote this is not a unique system, as even boutiques now implement this type of technology.

EQT's Hernell also stresses that Motherbrain and his other digital initiatives at the firm are meant to support fund managers, rather than make them obsolete. "Technology cannot drive out the more personal approach," he says. "We focus our technology efforts on data gathering and predictions, so we can free minds and free decision-making power to make better decisions on a larger scale."

Deep dive
Market participants agree that while technology can assist in the origination process, sector specialisation is also likely to form an important part of how GPs can win a deal. Says Stengel: "I do not think you find a lot of people just doing auctions without any differentiating factor. Firms like to have something they will bring to the table, perhaps a certain sector knowledge."

Carnimolla says that technology will push firms to specialise in more niche areas: "In the future, you will need to be an expert in a sub-sector. Given the richness of the data you get today, the level of expertise you will need to show will be much higher."

As Unquote has previously reported, European private equity funds have invested in fewer sectors every year since 2012, suggesting sector specialisation will continue to be important in the future of origination. Sector-focused funds are now rife and Stengel also mentions family offices, which are becoming increasingly competitive and have deep sector expertise in niche areas. They are often willing to pay high multiples for a business in areas in whey they have experience.

Many fund managers, such as Marc Theiry of Deutsche Private Equity and Peder Prahl of Triton Partners, have publicly spoken about the benefits of a sector focus. Not only does it allow investment professionals to avoid scattered cold-calling, but it is also advantageous to have knowledge of the sector to aid in value creation later in the holding period.

It is not just GPs that are increasingly spending time finding ways to stand out when it comes to origination – sector specialisation and technology-led boosts are now key battlefronts for the advisory community, too. Fenton Burgin, head of UK corporate finance advisory at Deloitte, thinks boutique firms developing strong sector knowledge and large players investing huge amounts of capital in their digital capabilities will outperform their mid-market competitors. "We are seeing the impact of artificial intelligence, analytics and big data modelling, and a big increase in the application of the technologies across the corporate finance arena," he says. But again, GPs' continued reliance on relationships, face-to-face contact and personal networks means these old-school attributes will continue to rank highly when it comes to the advisers they choose to partner with. "All investment banks have troops of talented executives, so what is important is that they really are plugged in," says 3i's Carnimolla. 

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• Topics
• Investments
• GPs
• Advisory
• DACH
• UK / Ireland
• France
• CEE
• Southern Europe
• Nordics
• Benelux
• EQT
• Ardian (formerly Axa PE)
• Project A Ventures
• 3i
• Alantra
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