How Do Private Equity Firms Find Companies to Buy | Venture Capitalist Explains

private Equity Funds like to Pride themselves on proprietary deal flow but the dirty secret is that most of the deals they do are still shopped but here's the thing just because shot deals are shopped isn't necessarily a bad thing especially if you're the seller stay the end and I'll tell you why private Equity deals are sourced in one of two ways it's either proprietary deal flow or shop to deal flow let's first start with shopped deal flow what do I mean by shop to deal flow well think about it like this you go shopping and you look at lots of different opportunities or vice versa somebody comes around door to door and you know they are shopping to you this opportunity that they have that's effectively what happens with shop deals they're usually run by an investment Bank the investment bank will have found a deal and they represent the seller in that deal then that investment bank will really be there to guide that company through the sales process in a lot of ways an investment bank is like a realtor but for businesses so they'll dig into your numbers they'll they'll help you put together your data room put together your full diligence package and make you look as pretty as possible just like a realtor will come to your house run the numbers help stage the house if there isn't Furniture put on open houses clean things up take beautiful pictures drone photography all videos all that fun stuff investment bankers are effectively doing the same thing they want to make you look as good as possible in front of potential acquirers then the reason you hire an investment bank is because they have relationships with lots of different private Equity Funds and those private Equity Funds if it's a good investment bank will trust to some degree the word of the investment banker so the investment banker can come and say hey we've got this great investment opportunity for you and here's why it's a company that's growing by 50 year over year and has great ebitda margins and not too much customer concentration and blah blah blah and what they'll do is they'll go to a bunch of different private Equity Funds they'll give them a keys are they give them a little bit of detail about it the private Equity Firm is interested then they'll sign an NDA and they'll say okay give me more details they'll look through the diligence package maybe they'll even do a call with the owner of the business or the c-suite of the business and then after that if they still like it then they enter into what's called a bake off or bidding process where a number of different private Equity firms will submit bids on the maximum amount that they would pay for that business and all these bids come in and then the owner meets with the investment bank and the Investment Bank helps them select you know which of those different private Equity firms they really want to narrow it in on or the one that they really want to work with and then they'll help represent the seller in that negotiation process helping them get the best deal possible and look it's not always about getting the highest price it could be a situation where like the founder or the owner really wants the business to stay in the community where he or she built it or maybe they want to have a second bite of the apple as they say where they don't sell the entire business but they sell you know 80 percent of it and they retain 20 and have the opportunity to sell the next time when the private Equity Fund sells as a way to generate you know additional Returns on their their investment so there could be a bunch of different structural things and the investment banker kind of helps in that whole process well that shopped deals and as you can imagine when a deal is shopped to lots of different and private Equity Funds and there are lots and it's an attractive deal then they're going to be lots of funds kind of vying with each other to get access to that deal and pay top dollar to do so the flip side of that is proprietary deals now proprietary deals are deals they're the private Equity Fund has a proprietary or they are the sole ones to have a relationship with that company and ultimately what that translates to is that hopefully they get a better deal now for the entrepreneur and the owner of the business it is possible that they get a slightly better deal because they're not paying fees to investment bankers and so sometimes you'll have really sophisticated owners of businesses that won't work with an investment bank and we'll just go directly with the private Equity Fund even then I think there's a tremendous amount of value to working with an investment Bank to help represent you and to play that like intermediary that can you know have the hard conversations without hurting the relationship if that makes sense so even even then in those cases where it's proprietary deal flow having an investment banker if you're the owner selling your business can be incredibly valuable and so I highly recommend like spending some time to search out a good investment banker to represent you during that process as well as Good attorneys frankly nonetheless proprietary deal flow is important to private Equity Funds because because it's through this proprietary deal flow that hopefully they can get better deals ones that aren't shop to a million different funds and by doing so get a better deal overall and generate better returns now how do private Equity firms develop this proprietary deal flow well honestly there are a bunch of different ways in which they can do it a lot of them will have large call centers effectively of analysts that are just calling entrepreneurs and so if you run a small business there's a good chance that you've received a letter or a phone call from some analyst some private Equity shop that's you know they got just a long list of companies and they're calling every single one and uh sure be flattered but the reality is they're probably not that interested in your business they just don't know anything about it and want to learn more other ways in which private Equity Funds will create proprietary deal flows through their own relationships or networks that they build so sometimes you'll have industry experts that are you know head of different organizations and alliances and you know business or organizations and so forth and through those organizations they've developed relationships with lots of different companies with service providers and others and while I'm talking about service providers that's another way in which private Equity Funds will Source proprietary deal flow is through these service providers so those service providers might be like lawyers it could be accountants and others that that help get them connected to companies that are really interesting because again if they can get in with that company before the company goes and start shopping their their company to other private Equity Funds oftentimes they can get a better deal ultimately these private Equity firms will do whatever they can to get an edge on sourcing that deal because again it helps them if they're the only buyer for the business which is to a disadvantage to the seller which is why I tend to recommend that you work with a good investment Bank to help you get the best deal even if you know who you want to sell to what is an investment banker charge well you should be prepared to pay roughly two to four percent of the overall transaction size so if you sell your company for 100 million bucks it's not uncommon to be writing a two million dollar check to your your investment bankers for their work ultimately a good investment banker will get you the best prize while also meeting your own personal objectives and they'll get hold your hand and guide you through the process my recommendation on finding a good investment bank is really to look at investment bankers that have done transactions in your same industry so if you know of another company in your industry that's been acquired recently or gone public or sold to a private Equity Fund then look at the Investment Bank that helped them in that Journey then look at the investment bank and see how many other Deals they have done done that were similar to that ultimately you want an investment bank that understands your business really well and it has the connections to the right investors that are excited to invest or to acquire your type of business sometimes I'll see you know companies work with a really small investment banks that don't have the reach of investors that is necessary to get a really good buyer for your business and sometimes I'll see investment bankers that don't have the experience to know how to appropriately underwrite a company because it's in an industry or sector that's unfamiliar to them and the problem with that is that they're not going to have the same level of credibility with potential acquirers that somebody that's in the space and has done a lot of these transactions will have ultimately I believe you get what you pay for in a lot of cases here and so be prepared to pay up but just you know know that if you're willing to pay up you might pay more in fees But ultimately you're going to get a much bigger better transaction another way that can be helpful in terms of finding an investment banker is finding a good lawyer and asking them who they have found to be successful and really professional and working through deals as well there are a lot of different investment Banks out there there's one for pretty much every sector and then of course you have your bulge brackets if you're a company that's looking to sell you for your business for north of 100 million dollars and it might make sense talking to some of the Bulge bracket investment Banks you know your Goldman Sachs is Morgan Stanley's Etc and each one of those big bulge bracket investment Banks they're not just like one big monolith they usually have smaller groups and within those groups you want to find the managing director that best fits your business so some will have like a health care team some will have a tech team some will have just a pure M A Team really kind of depends on what you're looking for and know that in many cases private Equity Funds are also hiring investment Banks to represent them as well to go out and find deal flow so there's a little bit of give and take just like there are realtors that help people buy a house same as their realtors that help them sell a house anyways hopefully this was a helpful overview of of how private Equity Works how they Source deals and the role of investment bankers throughout that process if you've enjoyed this video check out my video how to start a private Equity Firm with no money and get some insight on the other side of the table thanks foreign