Private Equity Acquisition: Criteria to Look Out For

Acquisition is a core component of private equity investment. It’s the process of a private equity firm gaining control or full ownership of a business in order to make strategic adjustments that secure returns in the long term. Getting a good understanding of private equity acquisition is essential for global entrepreneurs and business owners who are preparing their businesses for investment or sale. We’ve created this article outlining the core criteria private equity (PE) firms evaluate before proceeding with an acquisition, taking a global perspective, rather than a local or regional one, to ensure stakeholders anywhere in the world can make informed choices.

What Is a Private Equity Acquisition?

PE acquisition is the transfer of ownership or controlling interest of a business to a private equity firm. The aim is to make adjustments to the company during the holding period to create value before making a profitable exit. The typical lifecycle spans years, starting with expressing initial interest in an acquisition target, then performing due diligence, negotiating and completing a transaction, implementing changes, and finally exiting through sale, initial public offering (IPO), or recapitalization.

Common Acquisition Models in Private Equity

The typical PE acquisition models are:

• Majority buyouts – Acquiring a controlling interest, which enables firms to direct major business decisions.
• Minority investments – Acquiring a smaller stake, supporting and guiding existing leadership throughout growth rather than taking control.
• Roll-up strategy – Private equity roll-up involves investing in multiple smaller businesses in a single industry, consolidating them under a single entity.
• Platform investments – Acquiring a single business, using it as a foundation for building a larger portfolio of related companies.

Financial Criteria Private Equity Firms Prioritize

Financial criteria firms prioritize include minimum revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) thresholds, which help to ascertain if acquisitions are likely to be profitable. Good historical and projected cash flow performance also suggest reliability of earnings. Similarly, companies demonstrating margin sustainability and solid cost structure can offer good foundations for efficiency improvements that boost value. Finally, existing debt load and capital structure are evaluated to understand likely financial risk.

Operational Characteristics PE Firms Evaluate

Private equity firms will review a range of operational characteristics, beginning with how scalable the operation and infrastructure are. The strength and depth of the current management team are also crucial, highlighting whether adjustments need to be made for leadership’s capability to execute growth strategies. Additionally, the level of process automation and systems maturity is reviewed to establish how ready the company is for immediate expansion and efficiency adjustments. Finally, evaluating the risks in existing supply chains, logistics, and client concentration highlights the potential for challenges to operational stability.

Market Position and Competitive Landscape

The market share and competitive moat of a potential acquisition are vital considerations for private equity firms who wish to minimize risks. Additionally, establishing the level of brand recognition, client retention, and pricing power indicates potential for maintaining profitability and value growth. Firms will also look at broader industry growth trends and macroeconomic factors to better understand the likely sustainability of the acquisition. The regulatory environment and geographic footprint of a business will be considered, too, as these can reveal legal or market constraints that might inhibit performance.

Legal, Compliance, and Regulatory Due Diligence

Thorough reviews of legal risks and past litigation help private equity firms understand potential liabilities that could affect value. Thorough regulatory due diligence is also essential to understand any industry-specific compliance requirements and confirm the acquisition meets all necessary standards. This includes ensuring that all licenses, certifications, and labor obligations are being maintained. Furthermore, legal analysis ascertaining ownership of intellectual property (IP) and any contractual liabilities helps avoid disruptions and unexpected erosion of value.

Cultural and Human Capital Considerations

Confirming cultural alignment between investors and potential acquisitions can suggest how successful a partnership may be, minimizing hurdles related to ethics or working styles. Additionally, employee retention metrics and key person risk levels can indicate the stability of the workforce, which contributes to value growth. Reviewing how robust internal communication systems are and the consistency of leadership also helps private equity firms to establish the level of organizational resilience and readiness to implement changes.

Red Flags That May Deter Acquisition

What might deter acquisition? Unclear financial records or unaudited statements can raise concerns about transparency and liquidity. Overdependence on a single client or supplier can be a red flag for revenue stability, too. Firms may also find negative industry trends or increased regulatory scrutiny concerning, as these may inhibit future growth. Furthermore, a lack of integration readiness or gaps in leadership could complicate post-acquisition progress.

How Sellers Can Prepare for Acquisition

For business owners preparing for PE acquisition, the first area of focus is professionalizing financial reporting through a series of evaluations and statement standardization to enhance credibility. Addressing any outstanding legal matters and making certain the capitalization table is clear helps reduce any due diligence delays. Operational audits and process documentation are also useful tools for demonstrating the company’s change readiness and leadership control. Finally, clarifying internal values and principles shared by the business and its staff can help facilitate discussions with firms around cultural alignment.

Examples of the Largest Private Equity Acquisitions

There are various major PE deals across different sectors. In technology, some have involved multibillion-dollar transactions, in which PE firms have acquired controlling stakes to drive global expansion to raise value. Through private equity in healthcare, firms have acquired and consolidated multiple fragmented providers, consolidating them in roll-up deals to improve operational efficiency and brand recognition before pursuing IPOs. That said, some implications of these large acquisitions for stakeholders may include reduced autonomy for management teams, employee downsizing, and shifts in wider market dynamics.

Role of Consultants and Advisors in PE Transactions

Various types of private equity consultant services play important roles. Legal advisors draft and negotiate contracts, manage regulatory compliance due diligence, and undertake risk assessments. Financial consultants will usually perform valuations and financial modeling. Additionally, operational and human resources (HR) specialists can analyze company efficiency, ascertain levels of cultural alignment, and strategize integration processes. The earlier third-party consultants are engaged, the better opportunities they have to enhance the likelihood of a successful acquisition.

Global Trends in Private Equity Acquisition

There are some distinct global trends, including increasing interest in emerging sectors, such as healthcare, logistics, and fintech. Additionally, since 2020, there have been notable shifts in investment strategy toward prioritizing resilience and digitization, which reflects broader economic and technological focus in the business landscape. It’s also important to consider the presence of regional differences in acquisition patterns. The U.S. commonly focuses on tech and innovation, Europe is geared toward sustainability and regulated industries, and Asia-Pacific prioritizes finding market entry opportunities.

FAQs

What is a private equity acquisition?

Private equity acquisition is when a financial firm buys controlling interest or full ownership of a private company.

What are the main criteria PE firms use to evaluate a company?

Common focuses include financial performance, growth potential, market position, leadership quality, and regulatory risks.

How long do private equity firms usually hold a company?

4 to 7 years is the typical holding period before exit via resale, IPO, or recapitalization.

What is a roll-up in private equity?

Roll-up strategies involve PE firms acquiring and merging several similar businesses to build a stronger combined entity.

Can small businesses be acquired by private equity firms?

Yes, especially those showing high growth potential, strong margins, and scalability.

References

Dong, Qi, et al. (2020, October). Private equity exits after IPOs. Science Direct. https://www.sciencedirect.com/science/article/abs/pii/S0929119920301401

Khan, U. (2021). Effect of Employee Retention on Organizational Performance. Research Gate. https://www.researchgate.net/publication/355423175_Effect_of_Employee_Retention_on_Organizational_Performance

Edwards, B. (2024, November 12). Increased global regulatory scrutiny to impact private equity deal activity, survey finds. Global Legal Post. https://www.globallegalpost.com/news/increased-global-regulatory-scrutiny-to-impact-private-equity-deal-activity-survey-finds-227739062