Deal Origination in the Digital Era- Transactions Series #1
What do you think you would pay for a carefully selected and potentially profitable investment opportunity? Would you pay a team of three full time investment specialists for at least one year and who would spend at least 25% of their time rejecting around 80 opportunities to find that one good one for you? I am pretty sure your answer will be “NO”. However, if you have invested in a Private Equity Fund you would already be bearing this high cost for each one of your portfolio companies. By a rule of thumb, about 30% of your invested capital goes into funding the private equity fund administration and paying for the highly skilled specialists in these funds. So out of every $100 invested, only $70 is available for further investment.
Well, the good news is that as the private equity market attracts more and more money globally the funds are becoming more transparent. As there is more scrutiny the structures are becoming more efficient.
There are two very important aspects of the investment cycle for a private equity fund, these are: 1. Deal origination and execution 2. Management of exits from portfolio investments
In this article we will tackle the former and how the world is changing when it comes to deal sourcing and origination, which in simple terms mean how can one find high potential investment opportunities that are not currently available in the secondary market and invest in them.
Before we look at how the internet has changed the way deal origination is done, let’s look at the traditional deal sourcing strategies:
Source: Equire Funds, New York
As can be seen in the above diagram and without going too much into a detailed explanation, intermediary led transactions are the largest source of deals. Though these are very effective, they are a very expensive alternative. Proprietary transactions give a very high level of exclusivity but require hiring expensive experts in-house which might not be the most cost-efficient way to go. Off-network transactions are few and far between and are not very organized thereby increasing significantly the risk unless there is a strategic fit and or an opportunistic tactic while making an investment decision. That brings us to marketplace networks and this is where the revolution is happening.
Marketplace networks or simply market networks are now digital and are combining important aspects of marketplaces that provide transactions among multiple buyers and sellers and networks that provide to identify people through profiles and communicate in a 360-degree pattern with others in the network. The key focus is not just a quick transaction but action around longer-term relationships. The below diagram shows how market networks are created and function:
Source: NFX LLC
So, what would a market network look like for an investor looking to originate deals:
As you can see above, it is an all-inclusive network that brings everyone who can create value in a private placement together. This is the future and the pioneers such as AngelList have been paving the way and have been followed by the likes of iCapital. These along with access to robust private equity databases such as Crunchbase, Pitchbook, etc. will make the whole process more efficient both in time and cost as well as improve the quality of the analysis to aid well rounded investment decisions.