Inside the minds of private equity: What do they want to buy and why?

The straightforward answer is this: private equity (PE) wants to invest in businesses that have the potential for significant growth (‘upside potential’), as well as companies that will be able to hold their position and be resilient should market conditions deteriorate (‘downside protection’).  

And why? Because a PE investor will look to increase the value of a business, typically by doubling or tripling profits over a three-to-five-year period, respectively.

But how are growth and resilience typically measured by PE? 

Growth indicators

Strong management teams: PE investors do not run businesses. They back talented management teams to deliver a growth plan that each party believes in and signs up to. PE looks for teams that display a proven track record, and a balance of skills, commitment, and ambition.

A track record of historical growth: Although the old adage of ‘past performance is no guarantee of future results’ remains true, it’s about as good a proof point as is out there. Which is why PE spends the time and money they do due diligence on a company’s historical performance.

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A PE investor will look to increase the value of a business, typically by doubling or tripling profits over a three-to-five-year period.

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An attractive and growing end market: PE likes businesses operating in growing markets. Unsurprisingly, growing and growing fast are easier in high growth markets (where the size of the pie is increasing) than in flat or declining industries. PE investors typically hold an investment for three-five years so medium and longer-term prospects are important.

Scalability: Businesses that can grow quickly and efficiently are more valuable. 

Measures of resilience

High-quality earnings: Businesses with sticky, predictable revenues, which convert consistently and quickly into profits and cash will be seen to have high-quality and more robust earning potential. PE typically consider data looking back three years to make an assessment on the quality of earnings of the business over time.   

High barriers to entry: The harder it is for a competitor to enter a market, the more resilient a business is likely to be. Barriers can include valuable intellectual property (IP) or technology, long-term customer relationships or industry accreditations.

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