Deal Sourcing

A mutual fund manager can buy any listed share on the screen. An AIF manager cannot. The companies it is mandated to back are unlisted, and the workbook is blunt about why that makes finding them hard: "As they are not listed on the stock markets, their presence is somewhat invisible", and their business and financial details are not in the public domain as they would be for a listed company.

Deal sourcing is the answer — the process by which the investment manager identifies potential investee companies and carries them through to a completed investment. The workbook calls it "arduous", "difficult and gruelling", and "an essential skill required to be a fund manager in the AIF industry".

It matters twice over. It is how the fund finds its investments, and it is how the manager raises the fund in the first place: one of the key attributes of a successful AIF manager is "to be able to showcase an impressive pipeline of deals to back up their pitch for raising the capital commitments from investors".

Two ways a deal arrives.

Why companies usually go through a banker. The workbook gives four reasons: VC and PE investors value the reference the adviser brings; the company has no idea how to identify the type of investor it needs; there would be no external validation of its testimonials; and it may lack in-house expertise in structuring, valuation and negotiation.

The funnel. Of all leads and enquiries coming in, about 25% are typically taken up for further processing. After that come business due diligence, the management presentation, an investment proposal to the Investment Committee, negotiations, the preliminary investment memorandum and term sheet, due diligence review and the definitive agreements.

The manager's role. Chapter 3 lists deal sourcing first among the investment manager's functions: identify favourable opportunities, source and complete successful transactions to generate profit and support further fund raising. Much effort goes into prospecting and relationship management with investment bankers, chartered accountants, corporate advisers, consulting firms, senior corporate heads and executives, and policy makers — "a large part of the investment manager's time is devoted to networking".

The governance angle. The workbook lists interaction with investment bankers for deal sourcing among the critical areas for transparency, governance and ethics.

Illustrative figures. Deccan Consumer Fund II, a Category II AIF with Rs 900 crore of commitments, tracks its sourcing for a year.

Of the three completed deals, one came from a banker-run process for a Pune bakery chain; one from a proprietary database screen for profitable regional snack makers with revenue above Rs 100 crore, followed by a direct approach and an NDA with the founder; and one from a chartered accountant in the manager's network.

When the manager goes out to raise Fund III, investors will ask for exactly this table — the "deal flow and filtration process" and "percentage of hit rate" appear in the workbook's list of investment strategy points for fund due diligence. A thin pipeline is a reason not to commit.

Chapter 7 (Investment Process and Governance of Funds) opens with deal sourcing at 7.1 and walks through initial assessment and business due diligence at 7.1.1 and 7.1.2; Chapter 3 (Concepts in the Alternative Investment Funds Industry) lists it first among the investment manager's functions at 3.1.4. Expect a question on what "proprietary sourcing" means, on the roughly 25% of leads taken forward, and on why companies prefer to appoint an investment bank.

• Proprietary sourcing means internally sourced — by the fund's own research, networking and screens — not "sourced through a banker".
• About 25% of leads are taken up for further processing, not 25% invested.
• In a banker-run deal, the teaser comes first, then the NDA, then the CIM. In a proprietary deal, the fund often signs the NDA directly with the target.
• Deal sourcing supports fund raising, not just investing — the pipeline backs the pitch for capital commitments.
• A direct approach by the company is often counter-productive, according to the workbook, which is why appointing an investment bank is "both a convention and a preferred route".