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2022 Annual - (released February 2023)

SA's quarterly Private Equity & Venture Capital magazine

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The thin end of the edge

by Michael Avery

A recent report from Bain believes that as capital becomes increasingly commoditised across global 
markets, more private equity firms are specialising to gain an edge. This might mean focusing on a 
specific style of deal, or seeking opportunities that fit an investor’s particular value-creation 
profile or sector specialisation, as deal teams seek ways to source deals others can’t, and identify ways to create value that others don’t see. This specialisation can help firms differentiate themselves and stand out in an increasingly competitive marketplace.

However, some investors make the mistake of assuming that strong market growth equates to superior returns when choosing sectors. To achieve sustainable success in sector investing, it is important to develop a fine-grained understanding of where the firm has a competitive advantage, and focus on that. This means actively seeking out areas of potential value creation, and looking for opportunities where the investor can bring distinctive expertise, resources and relationships to bear.


This involves three kinds of inquiries: Are we in the right sectors? Are we in the flow? And how focused should our strategy be?


When it comes to sector selection, experts at Bain believe that firms should ask whether a given sector is the right place for them to invest, rather than just whether it is a good place to invest. This starts with a clear-eyed assessment of where the firm has a differentiated "right to win"; how effectively they are competing already; and what it really takes to be a world-class investor in the vertical. By understanding their core capabilities and staying focused on the most promising sectors, firms can assess whether they are truly ‘in the flow’ – that is, whether they are in a sector that offers both current returns and long-term sustainability.


Another crucial factor is understanding whether the firm is in the flow of deals in their target universe. According to Sutton Place Strategies (SPS), most firms see only 15% to 30% of the deals within their target universe, and even top-quartile performers typically see no more than 40%. Improving these results starts with gathering data on what the firm is missing, figuring out why those deals weren’t on their radar, and building the relationships and networks that raise their profile

among sellers and intermediaries.


Another key question is how focused the firm’s strategy should be. Making the right decisions about which and how many sectors to focus on relies on objectivity. Firms should ask how much potential really remains in their existing sectors, how much investment it would take to crack open a new one, and how that meshes with the team and resources they have available. Objectivity is key.


They should also ask whether their strategy is disciplined enough to create a virtuous cycle within their chosen sector.


Private equity investors are data-driven, but until recently, meaningful data to make these critical "where to play" decisions simply didn’t exist. However, this is starting to change. Data can now provide a window into sector performance and enhance a firm’s ability to develop rigorous answers to these essential strategic questions. New tools are replacing gut feel with real analysis, allowing firms to make more informed decisions about which sectors to invest in. This is great news for private equity investors, as it means that they can now get a comprehensive picture of the sector and make informed decisions on where to invest.

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