Would you invest in a company that sold only to one out of 80 leads? In fact, you have already made that investment – in your corporate venture group.
According to our data, the median private equity and venture capital inves-tor in private companies reviews more than 80 opportunities in order to make a single investment. The median fund required 3.1 investment team members to close one transaction in one year (see graph).
Private equity origination is an inefficient and labour-intensive process, even though an effective deal origination process is fundamental to successful investing. Private equity funds that employ a proactive origination strategy have consistently higher returns, driven by both greater quantity and higher relevance of incoming investment opportunities. We recently completed the firststudy of best practices in how private equity and venture capital funds originate new investments, published in full in the winter 2010 Journal of Private Equity.
We drew on our personal work experience with leading institutional investors, in-depth interviews with more than 150 funds globally, and our proprietary dataset of their origination practices. Our focus was institutional investors in private companies – primarily independent funds, but also corporate-affiliated groups. Based on our study, we have identified five recommendations to improve the volume and relevance of dealflow.
1 Build a specialised outbound origination programme. Growth investors with dedicated, large-scale sourcing teams are almost all top-quartile performers across stage, vintage, and sector. The largest practitioners of these programmes – including Battery Ventures, Great Hill Partners, Insight Venture Partners, Platinum Equity, Summit Partners, TA Associates and TCV – typically have between 0.75 and 1.25 dedicated deal sourcers for every generalist investment professional.
Riverside Company, a mid-market private equity firm, has developed a broad network of 24 senior, focused deal originators to produce top-quartile results in eight of their last nine funds. While some question whether these strategies are as effective in Europe given the market and cultural fragmentation, firms such as TA and Summit have found their European launches to be very successful – matching or beating the efficacy found in the US.
2 Create opportunities, instead of waiting for oppor-tunities to appear. A number of corporate-affiliated funds commented that they were the only entities within their firmfocused on investing. Unsurprisingly most of their colleagues across the company are too busy doing their respective day jobs to provide as much dealflowas they theoretically could. In response, the top performers invested significantenergy in educating relevant indi-viduals across the firm(for example division managers and business development specialists) on their needs and interests. Where possible, they tried to finda way to arrange internal rewards or at least recognition for col-leagues within the firm who helped source deals.
Kuk Yi, corporate vice-president of Best Buy and man-aging partner of Best Buy Capital, the investment group for Best Buy, said: "Our networks with the venture capital community and entrepreneurs are our most important deal sources, with 40% of flo. Another 40% is from our internal corporate network. Another 10% is from investment bank-ers, and 10% is random – for example a student mailed our chief executive (CEO) about an opportunity. We get higher quantity but lower quality from a typical internal source, because they are usually too narrow a fit- a company with an interesting product but not a good investment. We co-invest 60% to 75% of the time, which helps build relation-ships and credibility with the VC community."
A number of the funds we studied use an origination approach that allows them proactively to co-create companies or opportunities. Frontenac Company uses a "CEO first" strategy, partnering "deal executives" to source investments in these executives’ focus industries. Exigen Capital specialises in creating independent carve-out businesses by pulling out an existing cost centre from an industry leader – including people, processes and systems.
3 Use deal signals to look for targets which are both attractive investments and are likely to welcome an outside investor.In order to filterthe universe of companies, some inves-tors specificall reach out to companies flashing "deal signals". These investors are exploiting the wealth of informa-tion about private companies available online, increasingly leaked via social media. For example, Aliisa Rosenthal, director of strategic partnerships, Quid, reports that her research firmuses an increase in internet trafficas a sign of customer trac-tion at an internet start-up. Similarly, Quid tracks Twitter traffic about a start-up to gauge customer opinion. Teten Advisors is now building an automated platform for private equity funds to source new transactions based on these signals. For example, the firm will identify a private company whose CEO is getting older and who lacks a logical heir – such a person is likely to be receptive to an investor’s inquiry.
4 Leverage social media. Historically, institutional investors kept their investment strategies discreet. However, today about 10% to 15% of the 1,000 active venture capitalists blog, according to Jeff Bussgang, general partner, Flybridge Capital Partners. Although private equity funds have been slow to take up social media, some have been more aggressive. For example, lower-mid-market private equity fund MCM Capital saw a 150% increase in dealflowafter they launched a social media campaign.
5 Leverage your unique strengths as a corporate entity. As such an entity, you bring assets to the table that a conventional investor lacks, and these should be leveraged heavily. For example, you typically have deep intelligence in your industry and influence.You may particularly have insight on low-cost international sourcing options for manufacturing, which is typically hard for a small company to build. Emphasise these strengths in your marketing and your meetings.
Many potential investees had concerns about taking in capital from a strategic investor, for example about information leaking or being used against them in future negotiations. Another significant concernwas internal bureaucracy slowing down decision-making when compared with the speed of independent venture capital groups. These can be mitigated by structuring the corporate venturing group to be as independent as possible, for example separate brand name and physical office, and imposing strict information firewalls
More data on this research project can be found at teten.com/deals and at www.teten.com/executive
The authors
David Teten is CEO of Teten Advisors (teten.com), an investment bank that uses a proprietary technology plat-form to source transactions for private equity funds. He formerly was founder and CEO of Evalueserve Circle of Experts. He has started three companies, sold two, and is a former Bear Stearns investment banker and Harvard MBA. He is the lead author of The Virtual Handshake: Opening Doors and Closing Deals Online (thevirtualhand-shake.com). Email: dteten@teten.com
Chris Farmer is a venture partner with General Catalyst Partners (www.generalcatalyst.com), a leading venture capital fund based in Cambridge, Massachusetts. He is also founder and chairman of Ignition Search Partners (ignitionsearchpartners.com), a boutique executive search and talent advisory firmbased in San Francisco. Email: cfarmer@generalcatalyst.com
We thank Yujin Chung (Andreessen Horowitz) and Neha Kumar (Anklesaria Group) for their invaluable help in supporting our analytics; David Teten’s former colleagues at Evalueserve for their initial help in creating our database; and our interns Dan Clark, Nitin Gupta, and Nikhil Iyer. David Teten, chief executive, Teten Advisors, right, with Chris Farmer, venture partner, General Catalyst Partners