Blog > corporate finance > Seeking investment: What a Private Equity investor looks for
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Philip Atkinson
23 February 2024

Seeking investment: What a Private Equity investor looks for

What a Private Equity investor looks for

Private equity investment is a fundamental source of business funding that plays a pivotal role in facilitating the growth of businesses across various sectors. It involves equity financing, where investors provide financial support in exchange for a stake in a privately held company, away from public markets.

Private equity differentiates itself from venture capital through its focus on the growth stage of target businesses. While venture capitalists typically invest in early-stage companies, private equity investors tend to target more established ventures. Nonetheless, the overarching objective in both cases remains the pursuit of sustained growth.

Private equity investors encompass a diverse array of organisations with varying specialisation and investment preferences. Some focus on specific sectors, such as healthcare, while others adopt a broader approach, investing across multiple industries.

Certain firms exclusively pursue large-scale deals exceeding £100 million, while others concentrate on smaller transactions. Furthermore, some firms differentiate themselves with distinctive expertise, effectively assisting companies in international expansion.

Another differentiating factor is the level of control sought by private equity firms. Some insist on obtaining a majority stake, granting them decision-making authority, while others are open to being minority shareholders or co-investing alongside fellow investors.

In essence, there are several factors which determine a specific private equity investors’ interest in a particular business, including the sector, stage of the business lifecycle, geographic location, valuation, and financial position, but a common theme across the industry is preferred targets will have the following characteristics:

Strong market position and sustainable competitive advantages: This may seem obvious, but strong candidates for PE investment include companies that are market leaders with sustainable business models. This can be characterised by high barriers to entry, high switching costs, and strong customer relationships.

Multiple avenues of growth: It is always helpful to have a balanced and diverse growth strategy, so that a company’s success is not completely reliant on one driver. This could include growth through the introduction of new products, increasing the number of locations, finding new customers, increasing the penetration of current customers (upselling products), exploring adjacent industries, and expanding into new geographies, among other possibilities.

Stable, recurring cash flows: Due to the reliance on high leverage (high amount of debt finance), PE firms must find companies with stable and recurring cash flows to have sufficient funds to service all its debt requirements. This requires having low exposure to seasonal fluctuations in cash flows, as well as low sensitivity to cyclical fluctuations (i.e., are relatively immune to economic downturns and/or commodity prices).

Low capital expenditure requirements: Companies with low maintenance capital expenditure requirements provide management more flexibility in terms of how it can allocate the company’s capital and run its operations: investing in growth capital expenditures, making bolt-on acquisitions, growth in its core operations, or give back capital to its shareholders in the form of a dividend. Capital-intensive businesses will typically generate lower valuations from private equity firms since there is less available capital (after interest expense), and there is an increased financial risk in the deal.

Favourable industry trends: Private equity firms are continually searching for companies that are well-positioned to benefit from attractive industry trends, since it results in above market growth and provides stronger equity return potential as well as stronger downside protection for the investment. Examples include increasing automation, changing customer habits, adoption of a disruptive technology, digitalisation, changing demographics, increasing regulation, etc.

Strong management team: A strong management team is crucial to success as private equity firms will provide strategic guidance but will almost exclusively rely on management to execute their operating strategy. If a company does not have a strong management team, the private equity firm must have a replacement ready before even seriously contemplating the investment.

Multiple areas to create value: In addition to the characteristics above, a good PE target will also have multiple areas where the PE firm can create additional value. Examples include selling underperforming assets, increasing the efficiency of operations, pricing optimisation, organisational structure, and diversifying the customer base.

Having considered what private equity investors look for in seeking potential investment opportunities, what should a company seeking investment consider when selecting a potential PE investor?

Some considerations when selecting a private equity (PE) backer include:

Committed finance: A PE fund seeks stable growth in the companies it invests in over a term of typically 5 to 7 years. This provides the management team with time to implement strategic plans, and additional financing may be available for acquisitions or debt refinancing. A well-funded PE fund may inject further funding after the initial investment, for example to fund acquisitions or refinance third party borrowings. If further funding is a likelihood, make sure you discuss this early and get agreement in principal before committing to an investor.

Expertise: Aside from capital, the right PE investment brings strategic knowledge, commercial and financial expertise, management experience, and a strong network of contacts. These sophisticated investors aim to support and grow their portfolio companies.

Support for growth: PE funds prioritise sustainable and scalable growth strategies when making investment decisions. Successful implementation benefits both management and investors.

Aligned interests: Once a stake is taken in the business, the PE fund’s interests align with those of other shareholders and management. In case of difficulties, the fund is incentivised to find solutions based on previous experiences with similar issues in their portfolio companies.

Market validation: PE funds thoroughly investigate potential investments, seeking businesses with competent management teams and a track record of growth. Attracting a PE investor serves as recognition of the business’ strength and competent management.

Sector experience: PE funds differentiate themselves by demonstrating expertise in specific sectors. This expertise provides valuable resources, problem-solving capabilities, and relevant contacts that benefit the business. Partnering with a fund known for their industry expertise can positively impact partners, clients, and competitors.

Investigate the investor and define the deal: Just as PE funds investigate businesses, businesses seeking investment should obtain references and ensure compatibility. Different funds have varying strategies, including investment size, level of operational involvement, and exit timetable. It’s crucial to assess whether the fund’s investment profile aligns with the business’s objectives.

Ultimately, the decision on the most suitable PE fund should be based on its potential to work effectively alongside management and leverage the advantages inherent in choosing the PE route. Preparation is key, such as seeking advice, researching funds active in the industry, and networking to gather information. The more due diligence conducted before seeking funding, the higher the chances of finding the right fund.

Importance of Seeking Advice:

Entrepreneurs facing the critical decision of whether to sell a portion of their company are advised to seek independent advice. Obtaining professional insights is invaluable in making well-informed choices. This article aims to provide general information on the criteria private equity investors look for in potential investee businesses and shed light on the types of businesses that could benefit from such partnerships.

At Wilson Partners, as well as providing day to day accounting and business advisory services, we also have an in house business valuations team and a Corporate Finance team giving us the ability to advise clients through the full exit journey ensuring a smooth process and realising as much value as possible. For more information, why not get in touch for an informal chat.


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