Similar to my experience in more traditional PE investing, sourcing quality deals in the SMB space is really hard. In fact, it's even harder than the PE space because it's almost a perquisite to live in the same area that the business operates out of. After being asked for feedback and ideas around how to best source deals, I thought it would be worthwhile to write something that I could guide people to.
I think there are a few crucial principles to understand when sourcing deals:
When it comes to looking for deals, the most important step is to understand what you actually want to buy. It’s easy to pull out the size of business you want and the location, but it’s harder to narrow down the criteria of a business you like and even a specific industry. Before starting a direct sourcing approach, it’s important to answer these questions (as well as many more):
These questions shouldn’t be easy to figure out. It’s smart to look at every remotely interesting deal you see from a Broker until you can determine what you actually like. Once you have a few industries picked out, it’s time to get really smart. Your education should be focused on becoming better at diligence so you buy the right business and can build a post-close value creation plan.
Throughout your education process, build a document that outlines your interest in the space and why you think it’s a great opportunity for you. These ‘tear sheets’ can be a helpful way to gain credibility in the market. Ultimately, sellers and brokers want to deal with people who are smart and focused on a specific space because it increases their confidence that a deal will close and that they will see strong performance after the transaction.
Once you have your industries selected and your working educational tear sheets built, it’s time to start hitting the market. There are two key routes:
There are a lot of technicalities that go into the details of direct sourcing, but rather than build a how-to guide, it’s important that everyone figures out what makes their pitch unique and sticks with it.
The approach is relatively simple—the hard part is consistency. Most importantly, be thoughtful about the deal you want to buy, even if it’s been a year since you started.