9 Tips for Deal Sourcing that Actually Work in 2023
TL;DR – This post covers the following 9 tips for deal sourcing:
1. Define a sector of focus and map it
2. Look for deal signals
3. Bring in a domain expert
4. Recognize that deal sourcing is a numbers game
5. Know and practice the attributes of great deal originators
6. Use snail mail
7. Create great content
8. Know how to differentiate yourself
9. Use a Relationship Management product (like Galaxy) that is designed for investors
Define a sector of focus and map it
It’s tough to get deals done in market segments you know little about, and if you do happen to find an opportunity, it’s a lot more work to ensure you’re getting a good deal if you’re totally new to the market. The best deals are often found when you know more about a market segment than your competitors and you can leverage unique insights to create otherwise hidden value.
This is why it’s important to start with a market segment that you know well and to branch out systematically by looking at directly adjacent market segments (i.e., where you already have some experience). For example, if you know the automotive dealership market, start there and look at adjacencies like marine and power sports dealerships.
Deal sourcing can be time consuming and tedious work, which makes it all the more important to optimize your deal sourcing efforts. A highly focused search is usually more efficient than a broader search because you can get a deeper understanding of the target market.
We recommend tackling no more than 2-3 target markets at a time so that your sourcing efforts aren’t diluted and you can build up expertise in a niche. This approach also enables you to get a higher level of coverage in the target market (i.e. talk to most of the companies) which will fuel your understanding of potential investment opportunities and increase your overall chances of success.
Once you’ve picked a target market, the first step is to map it
The goal of market mapping is to understand the market size, how the various players are positioned and organized within the market as well as the key macro and microeconomic drivers of the market.
This knowledge will help you form an investment thesis, as well as prioritize your outreach. It will also come in handy when speaking with targets, as you will be better positioned to ask the right questions and differentiate yourself versus other investors.
You can never know too much about your target market and typically the market mapping exercise involves talking to domain experts (i.e. former executives in the space) and vendors, as well as conducting online research (websites, industry reports, news, etc.). We’ll go into more detail on market mapping in a future post but we recommend doing 4 to 6 week ‘sprints’ on a target market to determine if further, on-going sourcing effort is worthwhile.
Look for deal signals
Sales people will tell you that they are more successful when they sell to decision makers who recently experienced a ‘trigger event’. A trigger event creates a feeling of dissatisfaction with the status quo and a desire to seek something they previously didn’t need. A similar dynamic exists for owners (sellers) of businesses.
Deal signals are essentially data points that indicate to you as an investor that a target is ready for or interested in investment. They tell you when a company is likely to be receptive to an inquiry from an outside investor.
One example of a deal signal is if a company hires a new CFO. Another may be if the founder or CEO is nearing retirement age. Other examples include:
A PE fund is motivated to sell their stake because they are raising their next fund and/or the investment has aged over 5 years
A start-up hasn’t raised money in 2-3 years following an initial round (and may be running out of cash)
A large corporation is seeking to raise cash by selling subsidiaries
Death, disease and divorce among senior team members
Many SaaS sales teams have become masters at identifying sales signals and automatically generating outbound sales activities unique to each signal. One common example is to trigger emails or LinkedIn messages when someone ‘likes’ or comments on a specific topic.
Paying attention to deal signals like these allows you to proactively seek out companies that are more likely to welcome outside capital.
Bring in a domain expert
Industry experts are people who possess deep domain knowledge of a particular industry and they can be extremely helpful to deal sourcers looking to quickly understand a market.
We recommend using industry experts not only to help map a market (and identify potential targets) but also to originate and make warm introductions.
It is fairly commonplace these days for industry experts to be compensated by investors for making introductions that result in closing a deal (i.e. through a one-time 0.5%-2% commission on the deal value).
In addition to helping you identify and source deals, the insights industry experts can provide may be helpful in the diligence and valuation process.
Recognize that deal sourcing is a numbers game
Unfortunately deal sourcing activity rarely yields an immediate return and it can take years after the initial contact for a target to turn into a deal. With so much competition for the best investment opportunities these days, deal sourcing is truly a numbers game.
Each year private equity firms like TA Associates, who pioneered cold-calling and deal origination in the tech sector, call over 6,000 companies and visit more than 1000 companies, resulting in just over 10 investments. The majority of these investments start with a cold call and on average, it takes three years from the first conversation to close a deal.
Another software acquirer we spoke with had similar numbers – a 20 person deal sourcing team that speaks with over 7000 companies per year resulting in about 10 investments.
To manage the numbers game, it’s particularly important for small investment teams to focus on a niche, be consistent and track the pipeline numbers systematically.
Deal originators should track the conversion rate of their funnel (from nurture to NDA to LOI to DD to close) in order to determine their conversion ratios so that they know how much sourcing activity is required to achieve their goals.
Know and practice the attributes of great deal originators
We can learn from the best deal originators on corporate M&A teams, PE teams and search funds in terms of the key personal attributes that result in finding the best (and most) opportunities. The list is as follows:
Sound business judgment and adequate financial sophistication
While probably not a surprising list, we’re amazed at how many investment teams are missing one or more of these attributes entirely. Either you need to practice these attributes yourself or you should ensure that someone on the team has them.
While not a personal attribute, we will add to this list that the best deal originators also hold a job title that signals the appropriate level of seniority within the organization they represent (i.e. VP Corporate Development).
Use snail mail
In this age of technology-oriented marketing techniques, ‘snail mail’ remains a winning tactic when it comes to sourcing deal opportunities.
In our experience, while physical letters generally get less than a 5% response rate, if you do it well, their recognition rate is over 80%. That means that over 80% of the people to whom we sent physical letters, remembered our letter when we met them at a conference or cold called them to ask for a meeting. This can be the difference between lining up a meeting or not.
We also found that written letters had particular appeal to an older generation of founders/owners who seemed to have a greater appreciation for that form of communication.
The snail mail process that worked for us was to have a handwritten letter arrive looking a bit like a wedding invitation (i.e. premium envelope and paper). We would then send a follow-up letter about one month later, followed by a cold phone call 3-4 weeks after that. Every letter was individually tailored to the target individual based on an overall template.
We know of a few deal sourcing teams that had success following a similar approach and they went so far as to include a candy bar in the letter.
Create great content
There is clearly a growing need for deal origination folks to differentiate themselves and to demonstrate how they can add value. As noted by Marc Andreessen of Andreessen Horowitz when they hired former Wired Senior Editor Michael Copeland, “it gives entrepreneurs a great deal of comfort to already understand us before they walk in the door.”
This is definitely true for most founders, owners and executives of businesses looking to take on outside investment. Similar to the way consumers do research online before they buy, business owners do research into potential investors before they sell.
We’ve found that during outreach campaigns, targets frequently visited websites, blogs and other online content to check out the investor before engaging.
Creating great content isn’t easy but investors need some sort of digital presence. Whether it’s blogs, podcasts, eBooks, social media or something else, putting the time into creating great content is an important part of sourcing deals today.
Know how to differentiate yourself
This tip is directly related to creating great content because the best content demonstrates how you are able to add unique value as an investor.
Whether you’re reaching out through emails, meeting owners in person or talking to them on the phone, it is vital that you are able to clearly differentiate yourself versus the many other emails, calls and conversations the owner is likely having with potential investors.
Let’s start with what probably doesn’t differentiate you as a deal sourcer. There are literally thousands, perhaps tens of thousands of people out there trying to source deals every single day. Many of them represent PE firms or corporate business development and nearly all of them send out emails or make cold calls stating some variation of the following:
We take a long-term and flexible approach to partnering with founders and executives
We work collaboratively with management teams
We know your industry really well
We offer the best support for: attracting and retaining talent, go-to-market strategy, maximizing your valuation
There’s nothing wrong with these types of statements (assuming they are true) however, this messaging is generic and does little to help the target understand what is different about you as an investor.
You need to figure out how you are different from the competition and then ensure that the way you actually operate aligns with how you position yourself. Here are a few areas to think about in terms of ways you may be different as an investor:
Investment horizon (long vs short hold period)
Support for investment in R&D (organic growth)
Specific industry contacts (potential warm introductions)
Key values and support for a certain culture
Interest or history in backing specific missions