Origination: Sourcing deals behind closed doors

With auction processes becoming ever-more competitive, and potentially skewed in favour of bidders that have put in months of work prior to the event to develop relationships with management, is it still possible to forgo these situations altogether and source deals entirely off-market?

An idealist might suggest off-market transactions should present somewhat of a blueprint for the private equity industry as a whole. The skill of digging deep and uncovering hidden gems with considerable potential is the very essence of good deal origination. However, in many markets with established advisory networks, proprietary deals can often be hard to come by.

Time-sensitive
Auction processes can transition from first point of contact to completion in a matter of months and the winning bidder and highest bidder are usually one and the same; off-market transactions, by contrast, often take years to materialise - if they materialise at all. "There is no time pressure from the vendor's perspective but there is also no time pressure on the buyer," explains Ambienta founder and managing partner Nino Tronchetti Provera. "You have the time to fully understand the asset, which is very important and a luxury you do not always have during a competitive process. Also, you normally buy at very attractive prices and when you are coming into family-run companies, there are often many low-hanging fruits; areas where you can create value that are easily identifiable."

David Menton, managing partner at Synova Capital, explains how the firm sources proprietary deals by focusing on two aspects: data analysis and a thematic approach. "Being able to compile data on thousands of companies allows you to look at key metrics. You must then also have a sector-by-sector understanding of the marketplaces and areas on which you focus. You need a thematic approach and a willingness to delve into those sub-sectors on a regular basis through a variety of different channels," says Menton.

The data-driven approach to deal sourcing has proved fruitful for Synova – the success of its maiden vehicle meant its second fund closed on its £110m hard-cap after just three months on the road. However, as with the off-market deal-making process, data-driven deal sourcing is also a long-term and labour-intensive mechanism. "The majority of members of the Synova team below partner level focus on sourcing and origination as opposed to execution," says Merton. "It is a long-term play and something that is undertaken in a meticulous, systematic way. You have to be willing to make the significant investment in time, resources and the right quality of people."

As reliable as a data-driven approach may be, the ability to spot one-off opportunities can also be invaluable when sourcing deals at desirable valuations. Ambienta's Tronchetti Provera explains: "There might be some idea or fact that might highlight the potential for a deal – the age of an owner or a lapsing debt arrangement – something that indicates there might be a deal. You then have to find the correct way to approach the management, whatever that may be. The last company I approached was via somebody who was advising the business on patents."

One of the key features of proprietary deals – and indeed the reason they often result in lower entry multiples – is an emphasis on the relationship between vendor and acquirer. While pricing is certainly a consideration, it is not necessarily the most important aspect. As Three Hills Capital Partners' founder and managing partner Mauro Moretti explains, factors such as chemistry and agreement on the future development of a business are crucial. Moretti likens the three-to-four-year period spent getting to know each other to the foundations of a marriage: "If a couple is together for three or four years before they get married – as opposed to getting married a week after meeting each other – the risk of divorce decreases."

Moretti and Ambienta's Provera both believe the mature nature of the UK market makes it more challenging to source proprietary deals than in continental European markets. "In Italy, for example, it is easier to source off-market transactions because there is less competition and a more limited network of advisers," says Moretti. "In the UK that is more difficult. More patience is required and you have to accept you do not have the same level of dealflow in comparison with other markets."

Data at your fingertips
However, Synova's Menton believes there are many benefits to making proprietary deals in the UK: "There are tens of thousands of great companies in the UK and it is possible to source open access information on all of them. Whether it is a smaller company or a large company there is a certain amount of information publicly available at your fingertips. On the analytical side, that allows us to identify far more opportunities than we could find in other markets where information is not as readily available."

Regardless of the market in which a private equity firm operates, the keys to generating value from proprietary deals remain the same: patience, consensus and an in-depth knowledge of the asset's sector.

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