The private equity industry was struggling due to the global financial crisis and deal-making slowed down drastically over a decade ago, between 2007 and 2009. However, the industry made a bigger and bolder comeback and is still growing steadily. Private equity is favored by most companies because it gives them access to liquidity in comparison to alternative traditional financial sources that have high interest bank loans or listing on public markets.
But why do private equity firms invest in a company? PE firms invest in a company that shows clear signs of financial growth in terms of sales and profit in coming years. They have a simple goal. They invest in a company, create good value for four to five years generally and then sell their share for the maximum gain that is possible at the time. So, if your company cannot promise tangible financial growth, PE firms will not be interested in investing in the company.
It is better for companies that don’t require capital with steady cash flows and have a lot of fixed assets to probably look for a bank loan. Similarly, family businesses who only aim to maintain a stable living standard will not be able to offer attractive returns to PE firms. However, the companies that are growing faster, especially in specific sectors and don’t have fixed assets to pledge with bank for loan might be suitable to seek PE investment.
In this article, we have listed some important points that will help you understand what private equity firms look for in a company.
Ten years back the private equity (PE) industry was struggling due to global financial crisis and deal-making slowed down drastically between 2007 and 2009. However, a decade later the industry has made a bigger & bolder comeback and is still growing steadily. Private equity is favored by most of the companies because it gives them access to liquidity in comparison to alternative traditional financial sources such has high interest bank loans or listing on public markets.
But why do private equity firms invest in a company? PE firms invest in a company that show clear signs of financial growth in terms of sales and profit in coming years. They have a simple goal. They invest in a company, create a good value for four to five years generally and then sell their share for maximum gain that is possible at the time. So if your company cannot promise a tangible financial growth then PE firms will not be interested to invest in the company.
It is better for companies that don’t require capital with steady cash flows and has a lot of fixed assets to probably look for bank loan. Similarly, family businesses that aim to maintain a stable living standard only will not be able to offer attractive returns to PE firms. However, the companies that are growing faster especially in specific sectors and don’t have fixed assets to pledge with bank for loan might be suitable to seek PE investment.
In this piece, we have listed out some important points that will help you understand what private equity firms look for in a company.
Efficient Management Team
One of the decisive factors for PE firms is the quality of a manager as the firms will not be involved in the day-to-day operations of the company and everything has to be managed by top personnel. This is not effective in cases where the plan is to change the managers.
Strong Market Position
This might seem obvious but private equity firms prefer companies that are market leaders with sustainable business models. They are looking for high rates of growth, so it helps if the company is well positioned to grow within its sector.
Practical Business Plan
Private Equity firms are not interested in poor business plans with average growth. If the plan shows significant sales and profit growth, it is important that the company should have facts that support the business plan. PE firms look for annual growth of 20% – 25% and estimate that one of every five projects will be a failure, so they try to compensate for losses of one company with the profits of others.
Exit Strategy
While evaluating a potential company, the PE firms spend half of their time analyzing the investment and remaining to figure out how they will divest after a certain period. They plan their exit strategy from the very start. So, it is advisable for you to discuss their exit plant in advance.
Guarantee
Banks have a fixed return on loans, but private equity firms have no idea what their return on investment would be. There are chances that the company might go in bankruptcy and the firm would lose all their investment. Therefore, PE firms feel more assured when they are part of the board and can influence the management and make changes to the original business plan, if required.
Credibility
The main component of any company’s growth is its people. Due to this, the PE firms would like to check the market reputation of your key managers.
Emergency Plan
Business is unpredictable. It is important to evaluate the things that can go wrong and build an emergency plan so that if something goes wrong, the company is able to recover from it. This shows how committed you are towards the business.
Create Competition
There is a close link between the potential return and entry price the PE firm is willing to invest. If your company is lucrative and there are competitors who are ready to invest in it, private equity firms might agree to invest a larger amount and receive a lower return. Therefore, it is recommended to not negotiate with only one PE firm as this gives them leverage. Creating more competition might lead to higher investment and favorable agreement. However, to create it you need to have an excellent business plan, well-prepared documents and search for the most suitable private equity firms.
Multiple Sources of Growth
Private equity firms prefer to invest in companies that have balanced and diverse growth strategies, which means they are not dependent on only one driver. This includes new product development, expanding to new locations, new customers, entering new adjacent industries, among other opportunities.
Steady Cash Flows
Due to high risk, the PE firms find companies with steady and regular cash flows, so that they have sufficient cash flow to meet all the debt requirements. This requires low exposure to seasonal fluctuations.
Conclusion
Private Equity firms are very specific when they are looking to invest and not everyone is suitable for them. Hence, an expert advisor can help you understand whether private equity is the right option for your business or not and if PE is not a good fit for you, what should be your next step. In either case, you can reach out to our advisors to help you find the best option for your business.
