Would you invest in a company that only sold to 1 out of 80
leads? Or a company that typically took one year and 3
professionals just to close a single client?
In fact, you've already invested in that company: your
private equity fund. According to our data, the median investor
in private companies reviews over 80 opportunities in order to
make 1 investment. The median private equity fund required 3.1
investment team members to close one transaction in one year.
By the standards of most traditional sales processes, private
equity origination is a very inefficient and labor-intensive
process...despite the fact that an effective deal origination
process is fundamental to successful investing. This is
particularly surprising given that private equity funds who
employ a pro-active origination strategy have consistently
higher returns, driven by both greater quantity and higher
relevance of incoming investment opportunities.
We recently completed the first-ever study of how private
equity and venture capital funds originate new investments. We
drew on our personal work experience with leading institutional
investors, in-depth interviews with over 150 funds, and our
proprietary dataset of their origination practices.
Based on our study, we have identified five recommendations
to improve the volume and relevance of dealflow.
1. Build a specialized outbound origination
Investors with dedicated, large-scale sourcing teams are
almost all top-quartile performers across stage, vintage, and
sector. Professors Henry Chen, Paul Gompers, Anna Kovner, and
Josh Lerner found in a research paper that the best performing
VC funds are based in the major venture centers (Silicon
Valley, Boston, and the New York area), but their best
investments are outside of those geographies. The non-local
deals outperform by 4-5 percent.
Exhibit 1: Leading Late-Stage Technology Investors'
Portfolio by Geography, 2001-1Q2010
Notes: Only for IT & related sectors. Battery &
Sequoia data only include late stage/growth equity deals.
Exhibit 1 is a case study of the geographic diversification
of the largest late-stage technology venture capital / growth
equity investors. The funds with sophisticated non-venture
center outbound origination programs have almost all have
been able to raise funds equal or larger than their preceding
fund in the economically challenging period 2007-2010.
They are typically among the top quartile performers. By
contrast, most of the funds on the left with a local focus have
not raised new funds since late 2005.
2. Create opportunities, instead of waiting for
opportunities to appear.
A number of the funds we studied use an origination approach
that allows them to proactively co-create companies or
opportunities. VCs such as Benchmark Capital and General
Catalyst Partners work with Entrepreneurs-In-Residence (EIRs)
to develop their ideas, giving them an advantaged position to
lead an investment in any resulting company.
Private equity funds such as Castle Harlan partner with
leading corporations when bidding on investments, allowing them
to bring unique value and resources vs. other possible
investors. Frontenac Company uses a "CEO1ST" strategy,
partnering with "deal executives" to source investments in
these executives' focus industries.
3. Use deal signals to look for targets which are
both attractive investments and are likely to welcome an
In order to filter the universe of companies, some investors
specifically reach out to companies flashing relevant "deal
signals". These investors are exploiting the wealth of
information about private companies available online. For
example, an increase in Internet traffic is usually a sign of
customer traction. A family-run company that hires an outside
manager is flashing a signal that the firm may welcome an
4. Openly discuss your strategy, leveraging social
Historically, institutional investors kept their investing
strategy very discreet. However, today about 10-15 percent of
the 1,000 active venture capitalists blog, according to Jeff
Bussgang, General Partner, Flybridge Capital Partners. These
investors have found that openly discussing their investment
theses increases their perceived expertise and trustworthiness,
and thus generates dealflow. HealthPoint Capital has made their
blog a destination for M&A/investing information in their
5. Focus on co-investing with the best investors in
your target vertical.
VCs that are better networked at the time a fund is raised
subsequently enjoy significantly better fund performance, as
measured by the rate of successful portfolio exits over 10
years. Network centrality may be a better predictor
of future performance than experience or exits. One standard
deviation improvement in network centrality improves
probability of successful follow-on round or exit by 5.8
percent and performance by ~2.5 percent
We recommend you market yourself as the go-to co-investor
for target sectors by developing proprietary insights and a
deep network of key partners and talent.
The full research study will appear in the 2010 Winter
issue of the Journal of Private Equity.
More data from this research project is posted at http://teten.com/deals
and at http://www.teten.com/executive
Teten is CEO of Teten Advisors (Teten.com), an
investment bank which uses a proprietary technology platform to
source transactions for private equity funds, in New York, NY.
Farmer is Managing Partner, Ventures with Ignition
Search Partners (IgnitionSearchPartners.com), which advises
executive teams and investors on team building, developing
Entrepreneur in Residence programs, and talent-driven
origination strategies, in Boston, MA.