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1 March 2011

Chasing the rabbit: deal origination best practice

David Teten, chief executive of Teten Advisors, with Chris Farmer, venture partner at General Catalyst Partners, make five recommendations to improve the volume and relevance of dealflow.

Author: James Mawson, Editor-in-chief

Would you invest in a company that sold only to one out of 80 leads? In fact, you have already made that investment - in your corporate venture group.

According to our data, the median private equity and venture capital inves-tor in private companies reviews more than 80 opportunities in order to make a single investment. The median fund required 3.1 investment team members to close one transaction in one year (see graph).

Private equity origination is an inefficient and labour-intensive process, even though an effective deal origination process is fundamental to successful investing. Private equity funds that employ a proactive origination strategy have consistently higher returns, driven by both greater quantity and higher relevance of incoming investment opportunities. We recently completed the firststudy of best practices in how private equity and venture capital funds originate new investments, published in full in the winter 2010 Journal of Private Equity.

We drew on our personal work experience with leading institutional investors, in-depth interviews with more than 150 funds globally, and our proprietary dataset of their origination practices. Our focus was institutional investors in private companies - primarily independent funds, but also corporate-affiliated groups. Based on our study, we have identified five recommendations to improve the volume and relevance of dealflow.

1 Build a specialised outbound origination programme. Growth investors with dedicated, large-scale sourcing teams are almost all top-quartile performers across stage, vintage, and sector. The largest practitioners of these programmes - including Battery Ventures, Great Hill Partners, Insight Venture Partners, Platinum Equity, Summit Partners, TA Associates and TCV - typically have between 0.75 and 1.25 dedicated deal sourcers for every generalist investment professional.

Riverside Company, a mid-market private equity firm, has developed a broad network of 24 senior, focused deal originators to produce top-quartile results in eight of their last nine funds. While some question whether these strategies are as effective in Europe given the market and cultural fragmentation, firms such as TA and Summit have found their European launches to be very successful - matching or beating the efficacy found in the US.