Business Development Is Now Table Stakes to Win in Private Equity

On November 28th, a who’s who of middle market private equity business development professionals convened in a private room at the University Club in midtown New York. The entire day was dedicated to reviewing and revealing best practices on the art and science of middle market deal sourcing, discussing the continued evolution and growth of the business development role and its stature in middle market private equity.

Here are three major takeaways from the event:

1. Record levels of dry powder in the American private equity middle market are forcing GPs to pursue sector-based or capability-based specialization, which in turn is transforming private equity business development processes and practices
2. LPs realize how vital differentiation and sourcing has become for fund returns, leading them to inspect PE Business Development practices at exceptionally granular levels
3. Business Development has fully become a partner-track career path in Private Equity

What follows below is a review of each takeaway paired with quotes from business development practitioners who spoke at the conference.  

Takeaway #1: Record levels of dry powder in the American private equity middle market are forcing GPs to pursue sector-based or capability-based specialization, which in turn is transforming private equity business development processes and practices

“Dry powder has nearly doubled since 2011 in the U.S. private equity market; as of Sept 2017, U.S. PE dry powder was at a record $556B. This new market normal has intensified competition for deals to the point where BD professionals must be extremely articulate at differentiating their firm’s capabilities. Sourcing remains a human endeavor driven by relationships, but you must use sophisticated analytics to optimize your time and focus.”   Michelle Eidson, Managing Director, Shorehill Capital

“Back when Milestone was a generalist PE firm, it was much harder for me to know quickly what deals would be of interest to Milestone.  Now that we’ve specialized and picked three sectors of focus, it’s much easier for me as a BD professional to communicate our strategy with intermediaries, respond to them with conviction, and know how to wisely spend my time.”  Dan Ryan, Partner & Head of Business Development, Milestone Partners

While the decision to make the change from generalist to a specialist is fraught with FOMO, the current environment is so competitive that there isn’t really a choice.  Private equity firms must differentiate themselves to have a credible path to outperformance. When a firm preserves a broadly opportunistic posture, playing offense in business development is hard to execute for three reasons:

1. the BD leader / team can’t communicate a clear investment criteria into the investment banking and brokerage channels.
2. the firm lacks a memorable brand and differentiation narrative. Audax is known for buy and build. Vista is known for software and a proprietary value-creation playbook, Silverlake for tech. In today’s environment with over 4,100 PE firms, it’s a huge advantage for a PE brand to be known for something specific.
3. because any deal could be of interest to a generalist, tiering the intermediary market and prioritizing coverage of the long-tail intermediary universe becomes essentially impossible.

Once a private equity firm makes the strategic decision to differentiate, either by capability or industry, business development leaders can leverage data, relationships, and technology to define the target market of companies and intermediaries with whom they must become intimate. I suspect that the transition to specialization will take another 10+ years, as some firms won’t make the turn until succession planning has occurred and new leaders have taken the helm.

Takeaway 2: LPs realize how vital differentiation and sourcing has become for fund returns, leading them to inspect PE Business Development practices at exceptionally granular levels

“LPs are getting into the ‘how’ of the deal origination process. They want to know how exactly your firm does it.  They not only want you to prove to them that you do execute a business development motion, but that your approach is repeatable and scalable. Charts and graphs at the LP meeting are not enough, they want to know exactly how it’s being implemented day in and day out.”  Dan Ryan, Partner & Head of Business Development, Milestone Partners

“The maturation of the PE industry and the intensity of the competition for deals means that sourcing excellence is a tier 1 driver of a fund’s returns.  We all know that it’s true, the LPs all know that it’s true, it’s just a question of whether and how you act on it.”  Ted Kramer, President & CEO, Hammond, Kennedy, Whitney & Company, Inc.

Even private equity firms have a master, and it is the LP.  LPs have witnessed the competitive intensity of the current environment and are well-aware of the criticality of sourcing excellence as a driver of outperformance. They no longer buy the now dated and usually false “proprietary deal flow” sales pitch of decades gone by. As such, they insist on seeing detailed proof of the business development and strategic motions a PE firm makes that generate a unique sourcing advantage and that position the firm to have an advantage in competitive processes. As part of this due diligence, LPs not only are looking for the existence of a BD function inside the organization, but are looking for proof that the function is integral, culturally revered, and empowered to drive the firm’s deal funnel. BD Professionals that are simply “deal collectors”, a term coined by conference speaker Brendan Burke who leads Headwaters MB’s Sponsor Coverage, aren’t what LPs are looking for. They’re looking for a BD function that meaningfully helps the GP differentiate, build pipeline, and win deals.

Takeaway 3: Business Development has fully become a partner-track career path in Private Equity

“The Partner track career path for a business development professional isn’t a new idea in 2017. When High Road was founded in 2007, Director of Business Development was the first hire.  Not long thereafter High Road became one of the first firms to bring the role to the Partner level.  And it’s certainly become more common in the last five years as the rest of the industry has realized what a competitive advantage it is.”  – Rich Prestegaard, Partner, Business Development, High Road Capital Partners

It’s not a surprise to hear this quote from High Road, a private equity fund with Riverside Partners ancestry.  Riverside was notoriously far-seeing in its approach to Business Development, employing a large team of deal origination professionals decades before private equity became as institutionalized and competitive as it is today.  What’s changed perhaps is not the existence of Partner-level BD professionals, but how much more common it is to see BD professionals at the Partner table and on the Investment Committee. Andrew Bonano, Jay Jester, and Lex Leeming all are cases in point.  And perhaps for the first time in history, a middle market private equity partnership put forward their tenured and highly accomplished BD leader, Ted Kramer, to become the President and CEO when Hammond Kennedy, Whitney & Company executed their company succession plan.

Perhaps it’s best to conclude my reflection on the 2017 Capital Roundtable Private Equity Deal Sourcing Conference with a quote from Michelle Eidson, Managing Director at Shorehill Capital, who chaired the event. She reminded us all of Charles Darwin’s most piercing insight from Origin of Species in her morning keynote : “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.”

Writer’s note: for those of you who missed the conference but want access to all the content, Capital Roundtable offers the full recorded audio of the day here.