Being able to stand out from the pack is what gets a deal done with a private equity (PE) firm.

First and foremost, PE firms are financial buyers that seek to generate returns to their investors over a specific time horizon. Historically, PE firms utilized financial structuring (i.e. debt financing) to achieve their returns. As a result of increased competition and the general lack of inventory of quality opportunities, PE firms are increasingly focusing their attention on generating returns from operational leverage. This has led to a rise in industry-specific firms (i.e. focused only on one segment such as food and beverage or consumer brands), whereby operating partners with deep industry backgrounds are being employed to add significant value to portfolio investments through a number of growth strategies, for example, in expanding into new geographic markets where experience is essential. 

As such, private equity firms are focused on identifying the right platform investments for the portfolio, and seek to supplement these investments through additional synergistic acquisitions that align with their growth strategies in an effort to drive value. Generally these acquisitions can not only lead to cost synergies, due to overhead consolidation and economies of scale in buying power, but can also improve the potential exit multiple or valuation on sale, due to the increased customer and supplier diversification.

Given the changing environment, PE firms are looking for the following characteristics in a platform investment: 

  1. Growth industry – favourable industry trends allow PE firms to return above-market results and generate better returns than their peers. When disruptive technology or changing demographics, for example, lead to a significant opportunity, private equity firms are keen to invest or acquire at favourable valuations. In addition, companies in industries that demonstrate defensive characteristics during downturns, such as healthcare and food, are always high on the list of targets for PE firms.
     
  2. A sustainable competitive advantage – this may seem obvious, but strong investment targets include companies that are market leaders (or one of the leaders) with high barriers to entry (from a cost or technology perspective) and strong customer relationships. When intellectual property can be used to defend a market position, interest from PE firms increase.
     
  3. A balanced and diverse growth strategy – it is imperative 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; new customers; increasing the penetration of current customers (upselling products); exploring adjacent industries; and expanding into new geographies. In addition, having an area where PE firms can add value (for instance, by improving systems and reporting, or through process efficiencies or synergies with existing portfolio companies), increases the interest of PE buyers. 
     
  4. Recurrence of cash flows – recurring revenue leads to recurring cash flow, which will allow PE buyers to increase leverage and, hence, their potential returns without taking unnecessary risks.
     
  5. Low capital expenditure – allows for more flexibility to reduce debt, invest to expand or return capital to the shareholders.
     
  6. Management – strong management teams that have a proven track record delivering on growth initiatives are key. For instance, if an owner is seeking to exit, having a professional management team in place that has the relationships with the customers and suppliers, such that disruption does not occur, will lead to an increase in valuation and reduce a potential post-transaction retention or earn-out period.

While each PE firm has its specific criteria, and there are funds that focus on turnaround and restructuring opportunities, these characteristics are generally the initial areas of review when considering an acquisition or investment.

With the current credit markets, where the banks are open to providing capital to proven PE firms, the opportunity for a company that demonstrates these characteristics to realize a strong valuation is present. 

PE firms are disciplined buyers of businesses, and they review and perform diligence on many prospects before making acquisition decisions. Ultimately, a lot of these opportunities are rejected. So, when discussing a potential transaction with a PE firm, the key to maximizing interest (and hence valuation), is to focus on addressing these points in a manner that shows sustainability going forward.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.