What Is the Perfect Acquisition for a Private Equity Firm?

Venture capital firms focus on investing in companies that are only just past the startup phase. This sets them apart from private equity firms, who target businesses that are already in a stage of maturity. Private equity managers like Greg Lindae contribute both debt and equity to the transaction, creating a hybrid scenario. Buy-out firms and financial sponsors, both names for private equity firms, look for companies that aren’t publicly listed. They aim to stay invested in those companies for between three and seven years, after which they expect to implement their exit strategy and make a profitable return. Usually, recapitalization, mergers, sales, or initial public offerings (IPOs) are made at that point.

What Do Private Equity Investors Look for?

Many companies hope to attract private equity investors, because they will provide them with huge potential for growth. However, not every company is suitable. Specifically, investors like Lindae look for companies that:

  • Can generate cash.
  • Have an excellent management team.
  • Show potential for growth.
  • Can create value.
  • Have an exit strategy in place.

How to Create Value

There are a lot of ways in which people like Lindae create value in companies they invest in. However, commonly, they will look for a “platform” company, making further acquisitions to grow this. These “add-on” acquisitions are usually quite small, but they add value to the platform. The goal is to create a synergy so that the whole becomes more financially and operationally efficient.

Cashflow and Leverage

Next, debt (leverage) is used to ensure the capital invested can create a return. How much leverage is used determines by how likely it is for the company to generate enough cash to service it. The more cash can be created, the more debt people like Lindae will be willing to contribute. Leverage is used very aggressively, which is why most of the cashflow will go straight towards that in the early stages. Furthermore, any remaining cash is taken up by making the company grow. Hence, cashflow is the most important thing for private equity investors. They want to make sure that their strategies will increase the potential for more cashflow if they are to invest, in other words.

Exit Strategies

A private equity firm earns revenue by the cashflow of the company they acquire, but also by the capital gains they access when they exit the company. This is why the exit strategy must be firmly in place, as this is where the real returns on investment are made. The exit strategy is commonly known as a “liquidity event”, and is something that the financial sponsor works towards the entire time they are invested in the company. People like Lindae, meanwhile, are compensated by the “carry”, also known as “carried interest”, essentially referring to the profit distribution. Any money that is left after that goes back into the investment pot, after which a new target is identified and the entire process starts all over again.