8 things private equity firms look for in companies

Private equity isn’t for all types of companies. Their mission is to invest in companies (with a majority or minority stake), create value during a period of approximately four or five years and then sell their share with the greatest capital gain possible. Therefore, they look for businesses that show clear growth potential in sales and profits over the next years. If your company can’t offer this then they won’t be interested in investing in it. Once invested, private equity’s profits will depend on the growth and profitability of your company. If you win, they win. If you fail, they fail.

When your company or the market you work in are growing, a private equity firm might be able to help you. It might also be able to recapitalize your company, exit it or make a transition so that the management team buys it.

Companies that don’t need capital that has stable cash flows and a lot of fixed assets might be better off asking for a bank loan. The same goes for family companies who only want to maintain a good standard of living; they can’t offer a private equity firm the returns they’re looking for. However, companies that are growing a lot and don’t have fixed assets to provide guarantees to banks will need investors to finance this growth. Private equity is an excellent option or one of the few options that exist as banks won’t be willing to loan credit without guarantees.

What private equity firms look for in companies

1- A good management team: except when the plan is to change managers, the quality of a manager is a decisive factor for private equity firms, as they won’t be involved in the day to day running of the company, but the managers will.

2- A market segment that has growth potential: this is also an important aspect because private equity firms need high rates of growth. Another objective of private equity is to get a bigger market share, which makes it important that the company is well positioned to grow within its sector.

3- An ambitious but realistic business plan: a poor business plan with meager growth is of no interest to them. If the plan predicts important sales and profit growth, then make sure you can back it up with facts. Everything should be coherent.

You must bear in mind that private equity firms look for an annual profit of between 20% and 25%. They estimate that one in every five will be a failure and so those that make profits should compensate the losses of those that fail.

«To get annual profits between 20-25% the key aspects are: to improve company management (improving the EBITDA), obtain economies of scale for size or synergies, and try to buy cheap and sell expensive. 

4- Clear exit strategy: private equity firms say that when they study a company they dedicate 50% to analyzing the investment and the other 50% to studying how they can divest after a few years. Therefore, when they invest they already know how they plan to exit. For this reason, we advise you to ask them in advance how they intend to do this.

5- Security: unlike banks, private equity firms don’t know what their return on investment will be. In fact, they might lose everything if their growth plan doesn’t work and the company ends up on the brink of bankruptcy. Private equity firms feel more secure if they get seats on the board so that they can influence the management of the company, agreeing or vetoing changes made to the original business plan. It’s very important that you negotiate all these aspects well. This way, the shareholder’s agreement is balanced and that both parties are protected, not just the private equity firm.

«Private Equity Firms Look for the Return on Investment.

6- A contingency plan: in every business, there are ups and downs. Understanding what could go wrong and having a contingency plan ready in case it happens is essential. It will help build trust.

7- Reputation: people are key components in the development of companies. Because of this, the reputation of your managers in the market will be checked out before investing.

8- Return on investment: return is closely linked to entry price. If the company is very attractive and there are competitors trying to invest in it, private equity firms will be more willing to invest greater amounts and receive lower returns.

We don’t recommend negotiating with only one private equity firm as it gives them an advantage in negotiating opportunities. Creating competition usually leads to a higher price and a better agreement. Anyway, you must be able to create it, and that means having a good business plan and well-written documents, as well as searching for the most adequate private equity firms.

When negotiating with private equity, as well as correctly valuing your business, you will also have to go through different stages to help you maximize the final price.

 Download the eBook: How to value a company? Three main business valuation methods

Private equity is very specific when looking to make business, not everyone is suitable. Having the expertise of advisors can help you to figure out whether private equity is an option for your business. However, if it turns out that option is not a good fit, then you should think about what the next step could be. In either case, don’t hesitate to contact our team for strategic advisory.

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