For dealmakers in mergers & acquisitions (M&A), the dream is often to be the one that makes an eight-, nine-, or 10-figure (or even larger) deal. They're great press for your organization or firm and a big "feather" to put in your dealmaking cap. But the unfortunate truth is those deals are few and far between.
In fact, according to SPS, middle-market PE firms — which they defined as firms with an enterprise value between $50 and $500 million — drive a significant portion of the overall market. For instance, in 2023, while the upper market made a few hundred deals, middle-market PE firms made closer to two thousand.
Let's take a look at the middle market to better understand why private equity likes this space so much and how middle-market deal sourcing works.
While there is an undeniable appeal to making deals with large enterprises, they often come with a whole host of challenges. Not only are there fewer companies in general, but the options dealmakers have for striking a deal are similarly limited. As such, add-on acquisitions are far more prevalent than major platform deals.
In contrast, there are countless more middle market companies. Not only does this reduce how many firms come to the table for each individual deal, but it also enables firms to narrow their focus and take a more specialized investment approach. Plus, middle-market companies are often actively looking for funding rounds or gearing up for an initial public offering (IPO) or other exit. Such rapid growth often makes them more attractive as investment options.
However, this doesn't mean middle-market deal sourcing is easy. Nearly all middle-market companies are private, which makes simply finding information about them more difficult, let alone making a deal. Financial and operational information, for example, are hidden away behind locked doors since private companies aren’t required to publicly release this data.
To counteract this, middle-market PE firms source deals using a variety of methods and strategies.
For middle-market PE organizations, there are several traditional deal sourcing strategies that routinely make dealmakers' lists:
Private equity is — and likely always will be — a relationship-based business. Because of this, networking will continue to be a staple of how middle-market PE firms source deals. However, building and maintaining strong networks and vast connections in your chosen industry can only get you so far. That's why it's important to utilize varying deal sourcing methods to maintain a healthy deal flow.
A relatively newer platform for dealmaking (at least in terms of the nearly 80-year-old private equity industry), social media has quickly become a main driver for M&A. It offers not only an easy way to get information on and then contact company founders and stakeholders, but also a platform to help others follow your firm.
Another foundational deal sourcing method for PE firms, a robust conference and event strategy can help ensure your organization's pipeline stays full. That said, it's not enough to just attend events and hope to make connections with potential investment opportunities. It's far more effective to modernize your conference strategy and do research ahead of time to understand who's going, start building relationships, and make plans to meet weeks before the event actually occurs.
As we'll discuss in a bit, PE firms aren't solely responsible for sourcing their own deals. Middle-market deal sourcing often includes tapping into larger networks — which include investment bankers, family offices, and more — to get the scoop on potential opportunities.
Because of the companies that comprise the middle market, deal sourcing also means taking a closer look at the structure and leadership of those companies. Many middle-market companies are family-owned, and as their leadership ages, they may be good targets to make a deal with. Often, middle-market PE firms can approach these types of companies and offer a helping hand and mutually beneficial solution to a potentially stressful situation.
In addition to more traditional methods, middle-market PE firms must source deals by taking advantage of modern strategies. Not only does this mean adopting technology, but it also means using technology to augment your existing strategies and make them more effective.
Some of the traditional strategies, such as networking, have partially moved online, as we mentioned earlier with social media. But there are more pages that PE organizations can take out of tech companies' playbooks. Tactics such as email and marketing campaigns (including nurturing warm to cold leads through email) can help stir up new business.
Additionally, adopting technology such as deal sourcing platforms, CRMs, and sales acceleration tools can help make online deal sourcing more efficient and effective. With a comprehensive tech stack, middle-market PE firms can source more deals in less time with fewer people. These platforms also help ensure your team works more collaboratively and has more accurate, up-to-date information on your target investment opportunities.
Proprietary deals in private equity are highly sought after since they usually have better terms and less competition. But proprietary deals are even fewer and further between than enterprise platform deals. They require strategic sourcing and relationship-building since these companies aren't actively seeking investment.
Some PE firms have employed business development (BD) teams to play a crucial role in securing these deals. By focusing on sourcing and building relationships, BD teams can give firms an edge over competitors and make proprietary deal sourcing a viable — if relatively thin in terms of pipeline contribution — middle-market deal sourcing strategy.
In recent years, company and portfolio valuations have been on a bit of a rollercoaster. The high valuations of the pandemic market have since fallen, and multiples are still below historical averages. To bridge the gap, PE firms have had to change up their deal structures and strategies.
Rather than prioritize new platform deals, middle-market sourcing has focused more on add-on acquisitions and expanding existing platform companies. This way, organizations can take advantage of lower multiples and decrease their portfolio's average multiple while still using up the mountains of dry powder firms have available.
Throughout the M&A industry, there are countless firms and organizations that seek to make deals, and the number is only rising. With the increase in competition, however, most are choosing to become more specialized and find their niches, focusing on a particular type of company or industry for each PE fund or even for the entire firm. After setting clear ground rules so you don't step on each others' toes, collaboration can and should be a key method for how middle-market PE firms source deals.
To do that, building a strong network that includes a wide range of other M&A organizations should be near the top of your firm's list. Here are four of the main groups it makes the most sense to work with:
While PE firms source deals for themselves, that's often not the case for investment banking (IB) firms. IB tends to have a number of clients for whom they attempt to source investment opportunities, in addition to the deals they seek to make themselves. But middle-market PE organizations can use this to their advantage.
With solid investment bankers in your digital Rolodex, you have access to a wide range of contacts from every industry. And, as the "six degrees of separation" adage states, each of us is only a few handshakes away from literally any other person.
Partnerships between family offices and PE firms are common for a reason. The two types of investors may sometimes operate in the same industries — recently, family offices have begun to choose tech-based investments over their long-preferred real estate deals — but the fact remains their goals are largely separate. Family offices are keen on safeguarding and growing generational wealth, while PE firms may keep investments for several years to a decade at most.
For more long-term investments, family offices can be a great source of deals for middle-market PE firms. It's also possible a family office may approach PE so the family can make a direct investment and still have partial control over the growth of the company but gain all the benefits a PE firm can provide.
Firmly entrenched in the lower- to middle-market — and largely startups — venture capital (VC) firms are a great source for up-and-coming companies. As VC-backed companies exit the seed stage or reach higher funding rounds, they're prime targets for middle-market PE firms looking to make an add-on acquisition for one of their platform investments.
Other private equity groups may not be high on your firm's list of who to collaborate with, but trust us, they can be a great source of potential deals. PE organizations are becoming pickier about who they do business with and are setting clear rules for what is and isn't a good investment for their portfolio. But just because that investment isn't good for them doesn't mean it's a bad investment overall.
Keeping communication lines open with other PE groups can be a great benefit for your firm. Networking is all about making key connections with great contacts, so make sure to keep a few pages open for other firms in the same or adjacent industries. You never know what they may find that's a perfect fit for your team.
If your firm is tired of paying finders fees for deals, a deal origination service may be of interest. These services offer to "fill your pipeline" with potential opportunities that match your investment thesis, often for a flat monthly or yearly fee. These groups likely won't be the main source of deals for your organization, but they can help augment your internal team's deal pipeline, especially if you only have a couple of dealmakers in-house.
Above all, the key to middle-market sourcing is knowing who your ideal target investment is. Specializing in a particular field, company type, or industry means your firm inherently develops a much deeper understanding of your chosen niche.
This not only helps facilitate conversations with the appropriate stakeholders and target companies, but it also helps your organization become known for that knowledge. You could easily be sought out by potential companies because of your expertise.
So, for each of your funds, ensure you have an investment thesis. At a minimum, this should have:
On top of evaluating potential investments based on their company profile, it's also important to consider other factors when sizing up a deal:
Unfortunately for dealmakers, mergers & acquisitions don't happen in a vacuum. In fact, market trends and conditions can often be the reason a deal happens in the first place. Your firm could scoop up a struggling company rather inexpensively if the market ends up shifting away from them. Of course, there are other factors that affect how middle-market PE firms source deals:
For your firm to be successful, you must understand how to be flexible when factors outside your control occur. This is partially why firms employ multiple deal sourcing strategies and regularly analyze which methods are performing the best.
No matter what middle-market deal sourcing strategies your team decides to use, it's important to give them the right tools for success. In today's markets, it means adopting robust technology and software that helps your team be more efficient and make smarter decisions more quickly.
Check out our step-by-step guide to learn how dealmakers who use advanced data and technology are sourcing more and better deals.
