PE Firms are Honing Deal Sourcing Amid a 33% Drop in Deal Activity

New York, October 17, 2023 – Deals closed by private equity firms are down 33% from last year, according to analytics from the recently published 2023 Deal Origination Benchmark Report from Sutton Place Strategies, by Bain & Co. (SPS).

The report, released annually each fall, uses last-twelve-months (LTM) data for the year ending June 30, 2023. It provides detailed analysis on sponsors’ deal sourcing strategies relative to peers, allowing firms to gauge the efficacy of their origination efforts and identify tactical areas for improvement in the year ahead.

Each SPS client receives a custom DOBR comparing its market coverage to the overall industry and a peer group of similar private equity firms, defined by target investment criteria.

The 2023 edition includes results from 167 qualified PE firms segmented into 8 different peer groups, and it indicates that firms saw an average 17.8% of their target market deal flow – a slight decrease in Market Coverage from last year’s edition.

In line with macroeconomic uncertainty, data from the report indicates that median PE deals closed with a sell-side intermediary have decreased by an average 33% across all PE firms sampled, with firms in some peer groups seeing an even more dramatic fall-off. Upper Market-focused funds saw a 44% drop in total deal volume, on average, while median platform investments for Generalist, Middle Market firms halved.

One factor contributing to diminishing deal activity is the slowdown of buy-and-build strategies. The 2023 DOBR found that after the median number of add-on acquisitions jumped by 67% from 2021 to 2022, this amount has decreased by 40% since last year. This deceleration is likely tied to a lack of conviction in deal making due to rate hikes and shaky credit markets over the past year.

The drop in deal activity coincides with a concurrent, but less dramatic, decline in deal flow across the board. Median deal flow for private equity firms decreased by 6.9% during the period. Some peer groups, however, saw much steeper declines, with median annual deal flow for Generalist, Lower Middle Market and Sector Focused, Lower Middle Market firms falling by 19.0% and 27.4%, respectively.

During this time, the Pipeline Closing ratio, defined as the percentage of deals sourced that ended up closing, has decreased by 5%.

While the analysis indicates a significant slowdown of relevant deals coming to market in the current environment, PE firms’ Market Coverage, defined as the percentage of deals within target investment criteria seen by a given firm, has largely remained consistent.

On average, PE firms saw 17.8% of target market deal flow during the 2023 period, a slight decline from an average 18.2% Market Coverage in 2022. For some peer groups, this proportion has increased, indicating improvement in firms’ sourcing strategies within those groups.

Relatively flat coverage of relevant deals amid a dwindling volume of deal flow suggests weakening quality of deals coming to market for most PE firms.

To combat tapering deal flow, many funds are further emphasizing deal origination as a core practice, expanding their intermediary reach and ensuring maximum coverage. On average, firms in the Sector-Focused, Middle Market peer group have doubled the number of BD professionals on their teams.

Facing challenging economic conditions, SPS clients are evaluating the results of their custom benchmark reports to glean insights into the effectiveness of their deal sourcing. Firms are leveraging the results of this year’s DOBR to identify inconsistencies between their internal BD results and goals and apply those learnings to see more relevant deals.

Based on the unique comparison of their results to that of similar firms, SPS clients are able to capture areas of untapped potential, explore alternative methods, and implement appropriate adjustments to realign their sourcing strategy for the year ahead.

“Given the current market environment, firms are really scrutinizing their internal processes to identify inefficiencies. One key component to look at is the origination function. With Market Coverage across the whole PE industry below 20%, it’s still an area where firms are working to understand the methods and tools they can adopt to optimize this,” said Nadim Malik, founder and CEO of SPS.

“In our eleventh year publishing this report, it has become a unique piece to that puzzle which our clients look to for a health-check on their sourcing operation. We’re having our best year for client retention since our inception, with firms doubling down on their efforts to be more analytical and tech-enabled in finding and closing deals that otherwise might fall through the cracks. “

Private equity firms today are faced with a confluence of challenging factors affecting the external dealmaking ecosystem. With conviction in their coverage of target market deals, PE firms can ensure they are seeing the most relevant deals in any market environment.

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