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2022 was tough for M&A. Private equity deal volume was 46% lower than the previous year. Venture capital deals were down 42% globally in the first 11 months. And as deal volume slows, dry powder continues to grow, with more than $1 trillion USD in the US alone.
This surplus of cash coupled with a lack of deal flow means firms must change how they do business to succeed in 2023. While the first step is to supplement intermediary deals with a direct sourcing model, economic uncertainty is causing firms to refine their outbound strategies.
Dealmakers must find ways to be highly efficient with their time and search only for the most strategic investments. They must make a strong case for each and every transaction with a clear rationale of why this company should choose their firm amidst stiff competition.
The best way to do that is by carefully crafting an investment thesis and using it to guide your direct deal sourcing efforts. Keep reading to learn more.
An investment thesis is, quite literally, a thesis statement. It’s succinct, yet comprehensive enough to serve as your firm's guiding principle to both source and secure ideal investments.
Imagine you're back in school and writing a term paper. Remember how a thesis was treated as a single defining statement that guided the development of your entire paper? The same is true of an investment thesis for your private equity firm. Unlike your term paper, however, firms often have more than one thesis because they often focus on multiple types of deals at once.
Dealmakers’ theses can also be broken down into two specific types: top-down and bottom-up. A top-down investment thesis is something that helps your team understand and seek out ideal investment targets when sourcing.
Top-Down Investment Thesis for Venture Capital Example: "This $10MM seed fund focuses on US-based cannabis startups that are furthering the industry through technology and infrastructure research and development that can leverage our partners' vast experience in the logistics and supply chain sectors.”
Once your firm has identified an ideal company that fits its top-down thesis, it’s time to create a bottom-up version. Far more direct and specific in nature, a bottom-up investment thesis includes everything from particular information about the target company — including financial statements and forecasting, future business plans, funding strategy reasoning, industry trends, etc. — as well as why your firm is the best choice.
Bottom-Up Investment Thesis for Private Equity Example: "Smith Partners is seeking to invest a $20MM Series A round in Asclepius, Inc. to aid in their rapid growth and contributions to the advancement of the healthcare industry. Their dedication to modernization combined with SP's vast network of cutting-edge automation manufacturers and forward-thinking healthcare providers make this partnership particularly exciting."
A bottom-up thesis would then continue into specifics about the company, detailing financial and employee records, proprietary knowledge or advantages such as patents, and more about what your firm brings to the transaction. A final bottom-up thesis can take many different forms: e.g., a comprehensive document, presentation, or video.
The key to both a top-down and bottom-up investment thesis is specificity. Every thesis your firm creates should be valid only for your firm. The combination of geographic location, sector or industry, company stage or type, fund size, reasons behind the investment or focus, and your firm's specific differentiators should make each of your theses unique.
Creating an investment thesis framework will help your firm draft theses more quickly and make sure all of the necessary information is included. Answering the following series of questions is a good place to start building a framework for both top-down and bottom-up theses:
The framework you build from answering these questions can then be refined into a single statement or document that serves as your thesis. But be prepared to make iterations. You must continually refine your theses as you gather more data, learn more about your ideal investment, and the world continues to evolve and change.
Once your firm creates a thesis, it's time to put it to work. Remember that at its most basic level, a thesis aids your team in qualifying opportunities to see if they're worth pursuing.
Inputting the ideal criteria from your top-down thesis into a deal sourcing platform helps you map and understand the wider market, determine the most relevant conferences to attend, directly source the right opportunities, and much more. These tools can also help you learn more about specific target companies, their competitors, their investment readiness, and other key details to craft bottom-up thesis statements.
With over 130,000 sources and millions of data points, SourceScrub’s deal sourcing platform has helped firms improve their research productivity by 42.8% and deal sourcing pipeline by 36%. Let’s chat to find out how we can help you create and execute your investment theses in 2023 and beyond!