5. Establish a long list of potential deal targets and initiate coverage of these companies
The real action starts now! It is time to revisit the market map of the key players in the industry you created in step three. What companies on this list could be viable deal targets? Are you aware of any deal catalysts that could facilitate a private equity transaction? As I mentioned before, some companies will be on your list for benchmarking purposes only because they may be too large, publicly listed or already subject to recent private equity activity. Your objective at this stage is to review the market map thoughtfully and create a list of possible deal targets, some of which might consider a private equity investment in fairly short order and some of which will need to be converted into transactions over a period of time. It is a great idea to keep this inventory of deal ideas confidential and not mention any of the companies to anyone outside your firm in order to avoid leaking your proprietary ideas to the competition.
Now is a good time to become more familiar with the companies on your list. The only problem is that they don't yet know that you are looking at them, so you will have to initiate an in-depth coverage of these companies from your desk. Set up alerts that capture valuable information, such as financial reporting, regulatory filings, public statements, press releases, interviews and comments in business and trade journals. Analyze the presence of these companies on the internet and on social media platforms, especially if they operate in a consumer-facing sector. There are data analytics tools that can help you monitor and systematize vast amounts of data, such as the number of posts, quality ratings and customer reviews. If you need help in this domain, there are specialized firms who can provide social media monitoring and who will alert you of any meaningful spikes in traffic.
What are you looking for exactly? You need to stay abreast of any latest corporate developments and watch out for what Teten and Farmer (2010) aptly define as “deal signals.” These are trigger events that might make the company more receptive to accepting an investment from a private equity firm. They include any signs of instability affecting the corporation in the following areas:
Shareholders: parent company in distress, fighting off a takeover approach, private equity owner seeking an exit, large enterprises selling non-core divisions and any subsequent events following “death, disease, divorce,” especially in family-owned businesses.
Leadership: changes in strategic direction, succession battles, resignations and new appointments in the top management team or at board level.
Company performance: rapid growth that cannot be sustained with internal cash generation, production bottlenecks, large capital expenditure needs, persistent underperformance, excessive leverage or limited access to debt sources, or inability to exploit growth opportunities without additional capital.
Industry developments and pronounced structural shifts: industry consolidation or disruption, increasing rivalry among key competitors, new sources of pressure from customers or suppliers and any significant macro shifts creating the pockets of “economic turbulence” discussed earlier.
6. Rank the companies by attractiveness and approach two or three potential deal targets at a time
The time has come to start reaching out to the most promising prospects. By now you have hopefully spent enough time on desktop research of the companies on your deal target list and learned many noteworthy up-to-date facts about them. What's the best way to begin outreach? First of all, you will need to rank all companies in your deal inventory list: your top targets will be those businesses that feature the most obvious deal catalysts and represent the best fit with your investment thesis. Next, you will need to choose two or three top targets for your initial outreach. Why so few? Because reaching out to companies in a thoughtful and professional manner is time-consuming: you will need to craft a compelling initial message for each target and ensure that you follow up in an organized way. My advice is to start slow and add more deal targets only when you have fully exhausted the first few so that you are working on no more than two or three leads at any given time.
How do you contact companies? If there is no obvious way in through your firm's existing network and no possibility of a warm introduction by one of the industry experts you know, then the only way to make contact is through a cold call. Most private equity professionals feel nervous even thinking about cold calling, let alone going through with it. Unless you did door-to-door sales during your school years, you might have the same reaction to cold calling too. After all, most of us have developed a stigma toward irritating spammers and telemarketers, and none of us are in any rush to join their ranks. As humans, we also suffer from fear of rejection: when you make your first contact with managers of a company you know only through desktop research, there is a considerable chance that they will decline your request for a meeting. If they are inundated with cold calls, they might even make you feel bad about yourself for trying to solicit their attention. What then? It is good to remember that cold calling is an effective, time-tested strategy and that some private equity firms really excel at it. There are a few funds, such as TA Associates and Summit Partners, who manage to differentiate themselves in the crowded private equity middle market by pursuing prolific cold calling programs that involve making unsolicited calls to literally thousands of companies every year.5
It is certainly possible to make cold calling a success and design a more palatable process for everyone involved, even if you are the type of a person who cringes at the thought of cold calling. Below are my suggested steps to maximize a positive outcome from an unsolicited approach:
Prepare a compelling message. Review your research about the company and take note of any unique challenges that it is facing. If the owners of the company were to accept your investment, what do you think they might be using the capital for? What need do they have at an enterprise level that your fund can resolve? Once you have had an opportunity to reflect, prepare a creative and persuasive pitch that is specific to this business.
Do not call on the phone, write a letter. To maximize the success of your first contact with the company, you need to choose an approach that will make you stand out. In my view, there is no better way to do so than by sending a well-written letter that introduces your fund, demonstrates your thorough knowledge of the business, showcases your industry expertise and outlines the strategic rationale of working with your fund. The person reading the letter should immediately understand how partnering with your fund can help the company resolve its pressing needs and bring clear strategic benefits.
Approach a decision maker at the company. Make sure that you are addressing a person in a decision-making capacity, such as a shareholder, chairman or the CEO. If your deal target is a division of a large enterprise, then you need to approach the most senior person in the corporate development department.
Get the letter signed by a decision maker from your fund. You only get one chance to make the right first impression. The person reading your letter should feel that your approach is credible and made by a senior person with professional gravitas and decision-making capability. If your position lacks seniority, it is a good idea to get a senior partner from your fund to co-sign the letter as well.
Outline next steps. You need to suggest a process that will follow your approach. It might be a good idea to mention at the end of the letter that your fund would appreciate an introductory meeting and that you will follow up with a phone call in one week's time.
Attack from several angles. To make sure that your approach is successful in reaching the right person and is differentiated from those made by other parties,