Establishing proprietary deal flow has never been an easy proposition. But in the current LBO market, where it seems like every financial sponsor focuses on the middle market and has money to burn, finding a competitive edge is a daunting, sometimes impossible task.
In response, private equity firms are employing every possible strategy, some utilizing corporate executives to source deals, others stepping out of their investment comfort zone and selected firms hiring branding consultants to improve their image. But perhaps the most commonly used method of deal sourcing is one of the world’s most ancient selling tactics: cold calling.
“The style is as raw as you can get, but even if we don’t get the deal, we find we are a lot more knowledgeable than we would have been had we used an intermediary,” said Mike Dailey, president of Dailey Capital Management, which has done 25 to 30 deals after cold calling sellers.
To be sure, cold calling is nothing new. Firms like TA Associates, Summit Partners and Advent International have been cold calling companies for years. But in the last 12 to 18 months, when deals have been plentiful but highly priced, industry pros say cold calling has become the norm for private equity shops.
“Given the current state of private equity…firms have to do something different to source their deals,” says Andy Fligor, managing director with AFT Partners, an intermediary. “Firms are going to have to put more resources into finding deals.”
Jay Jester, director of marketing with the Audax Group, says it’s a function of increased competition. “People are doing a lot of competitive things. Venture guys are doing buyouts, mid-market guys are looking at turnarounds, firms are using equity to do mezzanine deals, so there’s a lot happening,” he says. “Anytime you have a dislocation and oversupply, people look for a new niche. And everyone needs to be looking for the unshopped goods.”
Veterans of the Cold Call
One of the reasons private equity firms are taking the time to cold call is because they’ve heard the success stories. Consider the case of One Call Medical Inc., a Parsippany, N.J.-based medical diagnostics outsourcer. TA first called the company in 1996 and periodically kept in touch before consummating its seven-year courtship with a $115 million buyout of the company.
“For as long as I have been here we have done cold calling. We originate two-thirds of the deals we close by cold calling. We get the other third from investment bankers and brokers. Eventually, the line starts to blur between the two,” says Brian Conway, a managing director with TA. “Sometimes an investment bank will give us a lead, but we have already been in touch with a company, which will sometimes give us an advantage.”
According to Conway, TA has 250,000 names in its cold calling database. From associates to managing directors, cold calling is just as much a part of the TA culture as closing a deal is. “A majority of our associates’ time, effort and incentives are in finding companies that more senior people can follow up on,” says Conway. However, as with One Call it can sometimes take years before the efforts ever yield fruit.
TA is not alone. While Summit Partners would not comment for this story, Fligor says it has about 20 associates in the same capacity as TA. Bob Taylor, a partner with Advent International, says about 50% of Advent’s investment opportunities come from cold calling. “It gives you a lot of exposure to different industries. Even during an auction process it gives you an advantage because you have valuable knowledge, which you can use to develop an investment thesis,” he says.
Advent tends to hire investment bankers and consultants, assigns them to specific industry sectors and lets the dialing begin. Surprisingly, Taylor says most companies don’t mind the unsolicited phone call, especially if the firm calling them doesn’t take an all-or-nothing approach to majority control.
“[The companies being called] respond pretty favorably. We can do control deals or non-control deals, and when you call a company and can offer them that kind of flexibility, it tends to help,” he says.
The level of sophistication in cold calling varies from firm to firm. At one end of the spectrum, some firms are no more scientific than your typical late-night telemarketer, calling through any lists they can get their hands on.
Experienced cold callers have a different approach. At Advent, for example, the caller has to know the sector of the company he or she is calling on. “We’re very sector focused, and the associates are very knowledgeable about the different industries and have done a lot of research for the companies they’re calling,” says Taylor.
At TA, the firm first decides which sectors it has interest in investing in, then TA’s employees head to trade shows and meetings. Eventually a very organized list is generated for the associates to get to work on. Each call is significant, as TA’s associates earn bonuses based on how many new deals they dig up.
Ted Clark, CEO of TASC Holdings LLC, a private equity firm that specializes in LBOs in the sealant and adhesives sectors, said that in a relatively short time his firm has already worked itself up to a database of over 1,000 companies in this niche. “We now have a whole team that calls, writes letters and sets up appointments. It is an active, ongoing and essential part of our business. It’s an important part of our strategy, and it’s been effective,” says Clark.
Dailey Capital Management uses what President Dailey calls “a tremendously deliberate approach” in cold calling. “We hear a lot of no’s, but what this process does is ensure that we know a tremendous amount of information on the sector and the target before we really get involved,” he explains. “We visit trade shows, spends a lot of time at the library reading Dunn & Bradstreet reports.”
An Icy Response
Despite its increasing popularity, some firms are still resistant to cold calling. Robert Manning, a partner with Baker Capital, said cold calling simply isn’t right for his firm. “Cold calling is a very mechanical way to approach deal flow. It really is not our style. We like to have an angle on every deal we do. And we like to have a partner [at the firm] with operational experience involved-and that brings networks and connections to the businesses we look to invest in,” he says.
Others firms say they will cold call, but are by no means ready to depend on the method as its main source of deal flow. “We cold call, but it’s not the firm’s mainstay. The scenario in which we operate best is where we can compete on a non-financial basis. If we have to compete on the best price, in a competitive auction, what that means is that we are the fund that accepts the lowest level of return for an investment,” says a buyout pro. “When we go out and target businesses, we lever off of our reputation and strength-cold calling doesn’t lend itself to that.”
The question, really, is whether cold calling is an option or requirement in today’s competitive environment. Audax’s Jester says no matter what your strategy is, deal sourcing should be front of mind. That helps to explain why even firms like The Riverside Company, one of the most active in the small end of the middle market, recently hired four regional sourcing and origination directors to pursue intermediaries and deals.
“In this business, you get promoted by doing deals, but that doesn’t make you good at finding deals,” says Jester, who prefers starting with the Z names when tackling a lead list. “If you are spending too much time closing deals, the process of looking for them starts taking a back burner. Closing a deal can take six to nine months and even then it could die. If you haven’t been able to line up another one, you wind up with a spotty track record.”