Private Equity Due Diligence: Business Private Equity Targets

Dec 07, 2021

Finding investors for your business doesn’t necessarily mean going public on the stock market. Many company owners decide to seek private equity investment in their business instead. What are private equity investments? They are investments made by firms that purchase shares in private companies in exchange for future profits. Private equity investors generally like to hold at least 50% of the value of a target business and tend to fund several companies simultaneously based on a common strategy, industry, or location.

What do private equity firms look for? Are there specific private equity investment criteria? Using and understanding the private equity due diligence framework below will answer these questions and can help position your company as an enticing opportunity for investors. 

Competitive market position

When pitching a private equity firm, you want to illustrate your business’ status as a force to reckon with in your industry. Highlight potential for sustainable expansion and competitive advantages that distinguish your business from your competitors. When developing a proposal for private equity purposes, make sure your pitch materials express:

  • The brand’s unique mission and vision
  • Detailed short-term and long-term growth projections
  • A strong, solid value proposition for your customers or clients
  • A comprehensive SWOT (strengths, weaknesses, opportunities, threats) analysis for both your business and potential competitors, along with a plan to manage the identified threats to your company
  • A five-year financial model with details about key performance indicators, operating margins, and projected market growth based on past performance

When presenting to a potential PE firm, prepare to answer questions such as:

  • Do you have a disruptive business model that changes expectations and processes in your industry?
  • What are your competitive advantages? Examples include integration, geography, distribution, brand awareness, cost, and innovative use of technology.
  • What barriers to entry do potential competitors have?
  • How much would it cost for a client to switch to your company from a competitor?
  • How has your company adapted to changes in your industry over the past five years, and how do you plan to do so over the next five years?
  • How saturated is the current market?

Strong management

Evaluating the management structure and team is a key part of PE due diligence. Investors need to know that the team has the skills, knowledge, and expertise to deliver on the promise of your pitch deck. Benchmarks of quality managers include:

  • Flexibility to pivot and adapt to reduce costs and improve efficiencies (implementing economies of scale, for example)
  • Sales acumen to attract new customers, partners, vendors, and other key stakeholders
  • Vision and skills to successfully translate the business’s strategic goals into real value for your current and target clientele
  • Track record of managing risks and taking advantage of opportunities

Diversified growth avenues

Your business should be able to illustrate several avenues for sustainable growth. Private equity firms may hesitate to invest in a company with a single driver of revenue. Developing additional opportunities can create a stronger position in the eyes of PE firms. Examples include:

  • Bringing your brand to new geographic regions
  • Expanding into adjacent niches
  • Increasing profits by upselling existing clients
  • Attracting new audiences
  • Adding locations
  • Rolling out new products and service lines

Stable cash flow

While there’s no magic revenue number for private equity targets, many investors are looking for annual profit margins of at least 10 percent, which can fluctuate based on the industry and risk profile. If you haven’t reached that goal yet, make a plan to improve your profit margins before approaching prospective PE firms. Smart strategies to increase the margins on your products and services include seeking savings synergies (such as economies of scale, outsourcing, or finding cheaper suppliers), and improving revenue (through increased sales or pricing), which will both boost the company’s EBITDA.

Limited capital expenditures

Companies with limited or decreasing capital expenditures provide the flexibility and freedom to pursue new opportunities and mitigate business challenges. Additionally, the lower your company’s demand for working capital, the more attractive you are to investors who want to maximize profit. Prepare answers to these common questions PE firms ask when evaluating a company’s need for capital during the private equity due diligence process:

  • How have your capital expenditures changed over the past five years, and how will they likely change over the next five-year period?
  • Are you anticipating any large one-time expenses in the near future?
  • What is your biggest downside concern, and how will the company address that concern?
  • How large of a deposit do you usually make for a major purchase?
  • How much lead time does the company need for purchase orders? 
  • What is your current output, and how fast can the company adjust this capacity up or down to meet demand as needed?
  • How much cash do you need to run the business in an average year?
  • How do you spend your operating funds? What percentage of those costs are variable vs. fixed?

Trending sectors and industries

Do you consider your business a disrupter in your niche? Are you distinguishing your brand from competitors by doing things differently? Companies that answer yes to these questions have a higher likelihood of interest from PE firms. Simply put, taking advantage of innovative tech and trends increases the potential returns investors may receive. If you’re not sure where to start, consider implementing solutions that help you connect with changing customer behaviors and demographics, such as artificial intelligence and automation.

If your business is seasonal or otherwise in a cyclical industry, consider fleshing out your offerings to become more attractive to PE firms. These investors tend to avoid committing resources to a company without steady year-round growth, which can prevent them from executing their eventual exit strategy. Most private equity investors want to see a return on their initial capital offering within five to seven years.

Now that you understand what makes a good private equity investment, you can improve your company’s chances of finding a PE partner that can drive real, profitable growth. Assembling a strong investment pitch and being well prepared for a private equity analysis could mean successfully scaling your enterprise for years to come.

  1. About the Author:

  2. About the Author:

    Bud Moore is a founding partner of Valesco Industries. He is responsible for managing the firm, strategy development, portfolio management, new investment origination, and team development.

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