7 Characteristics That Private Equity Groups Look for in a Business

CCA, Insights

by Timothy Brasel, | Feb 10, 2022


In today’s hot mergers and acquisitions market, private equity (PE) investment is fueling a growing share of the deals. Sometimes partnering with a PE group is the best way to obtain liquidity for your business, especially if you are in a high-growth industry and you see potential for bigger gains down the road. To attract the right partner, you need to know what PE firms look for in a target company.

Characteristics such as the following will help your business rise to the top of a PE group’s target list.


1. A Strong Management Team

Investors place their bets on a good idea; yet they also want assurance that the right people are in place to realize the idea’s full potential. PE firms will especially seek this assurance if they view your business as a good platform company, which they will bolt other companies onto over time. PE investors want to know that the target company’s CEO and CFO are competent to run the business today and capable of impressing investors tomorrow, when it is time to sell. If a PE group does not perceive that your current management team is up to the challenge, they will want to be ready with a plan to replace the team quickly.


2. Quality Revenue and Earnings Streams

PE firms will assess the quality of your company’s revenue and earnings, looking for two types of revenue in particular: recurring and reoccurring.

  • Recurring revenue is generated when you resell the same product or service to a customer repeatedly at regular intervals. A prime example of recurring revenue is a subscription-based service, which is the hallmark of SaaS (software-as-a-service) technology companies. With recurring revenue, investors look for a solid annual revenue rate (ARR) and monthly revenue rate (MRR), low churn rate, low customer acquisition costs, and high customer retention rate.

  • Reoccurring revenue is revenue that may occur again, although the customer is not contracted on an ongoing basis. If an HVAC company knows certain customers are likely to call every winter with a request for a heating system tune-up, the business generates reoccurring revenue; if the same company convinces customers to commit to a quarterly service contract, the business generates recurring revenue.

PE groups also like businesses that have long-term contracts, which enable them to forecast revenue further out, with greater confidence, based on the net present value of the contracted work.


3. A Solid Business to Build On

PE firms are attracted to companies that are well run, yet still present opportunities for growth or room for improvement. A business that has spent $1 million on bids and proposals in the last year and has a high probability of winning many of those contracts offers a good growth opportunity. A business that is generally well run but is not fully optimizing efficiencies offers room for improvement. While PE groups expect your business to have well-developed processes for critical functions such as operations, sales, and finance, these investors also like businesses that can benefit from improvements capable of driving higher margins.


4. A Diversified Customer Base

A diverse customer base is typically attractive to PE investors, since diversity helps reduce risk. However, there are times when a high concentration of customers in a market is desirable, especially if the PE group is eager to gain a foothold in that market. No matter how diversified your customer base, PE investors will expect that both your customer acquisition costs and your margins by customer type align with industry standards.


5. Opportunities to Deploy Capital

PE firms are under pressure to effectively deploy the funds their investors entrust them with, so they like businesses that enable good use of capital even beyond the initial investment. If there is potential to realize a strong ROI by expanding your product offering or building out the sales team, for example, then the PE group will view the acquisition as a good opportunity to deploy capital ongoing.


6. Industry Tailwinds or Consolidation

If strong tailwinds are fueling your industry’s growth—or there are good growth drivers on the horizon—that will pique a PE firm’s interest. Just the promise of a federal infrastructure bill boosted the attractiveness of engineering firms in the government sector, even before the bill’s eventual passing. Trends such as the aging population and increased incidence of chronic disease are driving growth in healthcare, while technology companies are benefitting from the rise in cloud computing, the explosion of e-commerce, and a focus on automating processes to reduce costs.

Consolidation opportunities also attract a PE group’s attention. In highly fragmented industries, PE groups will often invest in one of the dominant players, bolt other companies onto that business, and move functions such as human resources, finance, and sales to a shared services model that creates efficiencies. In a saturated market, where it is tough to grow organically, PE firms like to invest in businesses they view as good platform companies on which to build. For example, since government technology contractors find it challenging to attract and retain talent in today’s tight labor market, acquisition is becoming a more viable growth strategy within the government contracting sector.


7. A Mission-Critical Industry or Niche

Whenever laws, regulations, or societal expectations naturally fuel demand for a company’s products or services, that is music to a PE group’s ears. For instance, government contractors are required to secure their supply chains, which demands specialized software, while municipalities face clean water, clean energy, and other environmental mandates that require engineering capabilities those public entities do not typically have in-house.

If your business is exploring liquidity options and a PE investment is a consideration, it is important that you know what a PE group will look for in your business—before you are ready to start attracting suitors. Contact the investment banking experts at Chesapeake Corporate Advisors for advice on how to prepare your company for a possible PE investment, so you can achieve the best possible outcome.

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