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Increasing emphasis on deal origination as a core competency in private equity translated into better deal-sourcing results, per Sutton Place Strategies’ 2018 Deal Origination Benchmark Report analysis.

The DOBR is an annual report that compares the market coverage of a PE firm – the percentage of relevant, completed PE transactions with a sell-side adviser that the firm reviewed – against all PE firms as well as their peer group.

Median PE market coverage of relevant deals was 17.1 percent for the 12 months ended June 2018, compared with 16.6 percent for the year-earlier period. A total of 138 PE firms qualified to be included in this year’s analysis, of which 109 were recurring from the prior year and 29 were first-time contributors.

Deal sourcing has become a staple component of the LP diligence process, and PE firms have responded with better data, technology, and most importantly, people.

This is the first year that more than half, albeit slightly, of the 138 firms that qualified for the DOBR analysis had a dedicated business-development professional or team. Consistent with prior years, the “SPS Best-in-Class Deal Originator” award for having top market coverage in their respective peer group went to firms that had a dedicated business-development professional or team.

Median coverage of relevant deals represented by boutique advisers, defined as firms selling only one or two companies to a PE firm in the past year, improved even more dramatically to 10.8% in 2018 from 9.6% in 2017.

Given how high purchase multiples are, GPs and LPs alike recognize that “outside the box” and proactive deal-sourcing strategies can result in off-the-beaten-track investment opportunities, often at lower purchase multiples.

This competitive edge in a heated market can be the difference between average and top-quartile fund performance. It’s important to note that according to the SPS Sell-Side Process Index for intermediaries, more than half of boutique advisers typically run limited processes.

Surprisingly, each of the Generalist, Quasi-Generalist, and Sector Focused Middle Market peer group categories, consisting of transactions greater than $50 million in enterprise value, had a higher median coverage than the Upper Market peer group, which is comprised of transactions $250 million and greater.

There may be a misperception among larger funds that they are well covered from bankers, since there are fewer deals and intermediaries in this end of the market.

But even at the upper end of the market, funds can benefit from a more data-driven intermediary coverage approach, as well as having a dedicated business-development professional, triggering a substantial uptick in market share compared with their peers.

On the other end of the spectrum, coverage of Lower Market deals, defined as transactions in the $10 million to $50 million enterprise-value range, remains the most elusive for PE firms.

The median coverage in the Lower Market peer group actually fell, to 6.1% in 2018 from 7.8% in 2017.

This is the most fragmented end of the market from an intermediary standpoint, with a deals-per-intermediary ratio of 2.08 as per the 2018 DOBR, compared with as high as 3.17 in the Upper Market category.

The lack of efficiency in the Lower Market is what makes it attractive for PE firms, and optimizing deal origination could be a great way to cash in on these inefficiencies.

Deal flow is also up, which is not surprising. The median number of deals seen by a PE firm as per the 2018 DOBR was 560, compared with 448 last year, an increase of 25%.

What may be surprising is that the number of closed PE and M&A transactions in the 12-month period ended June 2018 was flat compared with the prior year.

PE firms may need to adjust their closing ratio expectations for the number of transaction opportunities it takes at the top of the funnel to close one deal.

Nadim Malik is founder and CEO of Sutton Place Strategies, a provider of data and analytics for PE and M&A professionals to optimize their business-development efforts. Reach Nadim at [email protected] or +1 646-418-2995.