How to Choose the Best Private Equity Firm

September 26 2024 | 5 Min Read Time

Jim Fray

E: jfray@pcecompanies.com

Follow me: LinkedIn

If you’re thinking about moving your company to the next level, you may be considering a partnership with a private equity (PE) firm to strengthen your business. But how do you determine which firm is the best match for your company — the firm that will enable you to achieve your strategic and financial goals? Although the process of finding the ideal partner can be challenging, knowing what to look for will help narrow your search considerably.

What Is a Private Equity Firm?

Private equity firms (“PE Firm”) are involved in roughly 35% to 40% of all transactions. The PE firm raises money from investors (i.e., pensions, foundations, trusts, individuals) and creates an investment vehicle called a “fund.” The mission is to make acquisitions of companies with the purpose of maximizing returns for investors.

Each PE fund is typically required to return investor's money within ten years, with a mandate to invest the committed money within six years. These restrictions push the PE firms to exit investments within five to six years. Additionally, some PE firms may have unique expertise in deal structures and industries based on the collective experiences of the firm’s leadership and investors.

Here are some of the most important aspects to keep in mind when searching for a private equity firm to invest in your business.

Industry Strengths

The first step in finding the right PE firm is discovering the firms that invest in your industry; doing so helps ensure they understand what makes your company unique and why it’s a good investment. Many PE firms have industry-specific expertise, so if that is a key requirement for you—you will want to look for a group that has invested in companies similar to yours.

The optimal buyer with industry experience will be the buyer that can help grow the company, creating opportunities for employees, and maximizing the investment returns for all. The PE firm will typically have an established group of industry experts to drive profitability and growth for your business. You should review the PE firm’s past and current investments to see if they are similar to your business. If you find no similarities (e.g., manufacturing instead of health care), the firm is probably not the best fit for you.

Many PE firms are “industry agnostic” but can still provide significant value to your business. Their approach is slightly different than that of the industry-specific PE firm: The generalist investor is able to view growth opportunities through shoring up the resources around you. Instead of imposing the traditional industry trajectory on your company, an industry-agnostic PE firm may bring new processes, technology, and leadership that embrace your vision. Additionally, a generalist investor may bring a fresh viewpoint to consider and have a group of partners on hand to provide vital knowledge in your industry.

Business Cycle

Which part of the business cycle your company is in determines which private equity firm is best suited to partner with you. Some firms specialize in the early stages and development of a business, whereas others are looking to invest solely in mature companies. Identify how your company will continue to grow. Communicating the continual growth potential to PE firms is key to realizing the targeted investment return.

Company Size

A key benefit of partnering with a PE firm is the ability to foster the continued growth of your business with access to additional capital. Private equity funds come in many different sizes based on the amount of committed capital raised from investors. Each fund will cap the amount of investment in each company to a certain percentage based on the total available capital.

For example, if the fund has $200 million in committed capital to invest, the PE firm may limit each investment to 10% of the fund size, meaning the maximum investment will be $20 million. So, you need to make sure that the fund is large enough to buy your company and make additional capital investments to grow your business.

To further illustrate, say you are selling your business, which has an enterprise value of $50 million. The PE firm isn’t going to invest solely with cash; it will use debt to facilitate the acquisition. In this example, the $50 million enterprise value will be funded with 50% debt and requires a rollover component from you of 12.5% of the purchase price. The resulting proceeds to you would look like the following:

Proceeds from selling your $50 million company breakdown In this scenario, you receive 85% of your company’s value, and through reinvestment you own 25% of the company going forward.

If the cash investment is near the maximum investment limit, the acquisition may not be an ideal fit. You want to choose a fund that has additional investment capacity. Otherwise, you will have missed the advantage of having a PE firm as a partner.

Platform vs. Add-On Acquisitions

Depending on the size of your company, sometimes the investment is considered a platform investment for the PE firm. A platform investment is usually a larger company in which the PE firm invests that grows by either acquiring other companies to add to the platform or by augmenting organic expansion. Growth through acquisitions allows the PE firm to enhance the platform investment and potentially boost the return to investors. Somewhere between 75% and 80% of private equity acquisitions are considered add-ons to an existing platform investment.

Be realistic about the value of your company. If your business is on the smaller side, the purchase of your company by a strategic buyer (an existing company) is likely. Approximately 85% of all companies sold go to other companies (this includes PE firm add-ons).

You may lose the senior leadership role that you have become accustomed to—and retirement may be on the horizon. If you are not ready to retire, find a PE firm that will invest in a company of your size and encourage the autonomy of the business as a separate platform, or one that needs you as part of its platform company. Be upfront about your personal goals, which will help you identify the right partner.

Questions to Ask Before Choosing a PE Firm

The best metric to evaluate a potential partner is to speak with past companies in which the PE firm has invested. Historical actions often indicate those of the future. PE firms publish current and past investments, so look closely at which companies they have invested in and in what capacity. Ask to speak to the business owner of the portfolio company to assess how the PE partner was to work with after completion of the deal. Ask the following questions:

Did they understand how to help manage adversity?
Were they willing to invest additional growth capital?
How did they work with the company’s management?
Did they act like the eight-hundred-pound gorilla during board meetings, or were they true business partners?
Most important, did they behave the way they promised and keep their commitments?

Investigating the relationship histories will indicate how the firm will likely behave with you: collaborative or something less attractive. A critical factor in choosing a PE firm is knowing where you fit in the company post-transaction, and if that role is appealing.

Know What Type of Investment You Are Seeking

Not all PE firms’ investment structures are the same, and knowing what type of investment you desire is crucial in selecting a partner. Investments in businesses take on several forms, and each firm has a preferred investment structure. PE firms will invest in either debt or equity, with the equity in either a control or a non-control position. The debt issued by a private equity firm may also contain an equity component, such as warrants or options.

Because of the level of involvement the group will have with your company, the debt structures will feel more like equity once the funding occurs. The PE firm will typically require monthly reports and meetings as though it is your equity partner. If you sell a minority position in your company, you will need to balance the benefit of the sale against the added influence on your decision-making process.

Most private equity firms have found the best way to stay apprised of potential deals in the marketplace is to reach out to investment bankers and develop relationships with them. Investment bankers know which PE firms are interested in which transactions, and they have a network already established. Working with an investment banker and leveraging its referral network will ensure these considerations are addressed and help you find the partner that will be the best fit for your company.