Our 6 Main Criterion
Strong market position and sustainable competitive advantages
Candidates include companies that are market leaders with sustainable business models. This can be characterized by high barriers to entry, high switching costs, and strong customer relationships.
Stable, recurring cash flows
Companies with stable and recurring cash flows in order to have sufficient cash flow to service debt requirements. This requires to have relatively low exposure to seasonal fluctuations in cash flows, as well as low sensitivity to cyclical fluctuations (i.e., relatively immune to economic downturns)
Multiple avenues of growth
Balanced and diverse growth strategy, so that a company’s success is not completely reliant on one driver. This could include growth through the introduction of new products/services, new customers, up-selling current customers, and exploring adjacent industries.
Low capital expenditure requirements
Companies with low maintenance capital expenditure requirements provide management more flexibility in terms of how it can allocate the company’s capital and run its operations: investing in growth capital expenditures, making bolt-on acquisitions, growth in its core operations, or give back capital to its shareholders in the form of a dividend.
Favorable industry trends
Companies that are well-positioned to benefit from attractive industry trends, since it results in above market growth and provides stronger equity return potential as well as stronger downside protection for the investment. Examples include increasing automation, changing customer habits, adoption of a disruptive technology, digitalization, changing demographics, etc.
Strong middle-management team
A strong management team is crucial to success as private equity firms will provide strategic guidance but will rely on management to execute their operating strategy. If a company does not have a strong management team, the investor may need a replacement ready before even seriously contemplating the investment.
Due Diligence Overview
Competitive Landscape and Market Position
- What is your competitive advantage (e.g. product offering, technology, price, premium brand, distribution capabilities, geographic presence, fully-integrated solution, etc.)? Is this a disruptive business model (i.e., one that changes the landscape of how business is done in this space in some way)?
- What are the barriers to entry into the business? What are the costs of switching to a competitor’s product?
- Where does the company fit in the industry value chain? How has the industry changed over the last 5 years? How do you expect that to change over the next 5 years?
- Who are your main competitors? From whom have you been gaining/losing market share? What firm is the biggest threat to your company? What is the biggest share gain opportunity?
- What is the market landscape (e.g. oligopoly, fragmented market, first-mover, etc.)? How saturated is the market?
Industry Growth/Addressable Market
- What is the historical growth of the market? What is the projected growth of the market over the next 5 years? How mature is the industry?
- What is the total addressable market? What segments of the industry are growing faster than others?
- Describe the key macroeconomic drivers of the business. What are the trends?
- Have there been any significant changes to the industry landscape (e.g. disruptive new entrants, consolidation, vertical/horizontal integration, demand/supply imbalance, etc.)?
- What are the regulatory concerns and how can it adversely affect the business?
Customer Base/Suppliers
- How many customers do you have? What is the concentration of your top 50 customers?
- What is the typical contract length of a customer relationship? What is a typical renewal rate? What percentage of customers have multiple products?
- Who are the key decision makers for the customers? What are the buying dynamics? How long is the entire sales process?
- Please describe your most recent customer wins and losses. What were the main reasons?
- How many suppliers do you have? What is the concentration of your top suppliers? How large of a customer are you to them? What is the average length of the relationship? How often are your supply contracts renegotiated?
- If you receive price increases from your suppliers, are you able to pass it through to your customers?
Capital Requirements of the Business
- How capital intensive is the business? What percentage of capital expenditures is growth capital vs. replacement/maintenance capital? How has that trended over the last 5 years? What kind of lead-time is needed (i.e. time from purchase order to delivery) when making a purchase order? How large of a deposit is customary for new purchases?
- How cyclical is the business? Are there any severe seasonal changes in demand? What are the factors? How much visibility do you have in expected sales?
- What percentage of the COGS cost structure is fixed vs. variable? What is the breakdown of operating expenses?
- What is the normal working level of cash to run the business for a year?
- At what manufacturing capacity is the company running right now? How quickly and to what extent can it be reduced if demand falls?
- What would be your biggest concern in a downside scenario?
Financial Performance (Historical & Projected)
- Provide a comparison of the historical performance to the management budgets for the last 5 years. Describe the methodology behind the budget and the reasons for beating/missing the budget.
- What are the key performance indicators (KPIs) the management uses to monitor the business? Describe the trends in these indicators.
- Break out your organic growth over the last 5 years (not including the impact from acquisitions).
- Provide your 5-year financial model and describe the key drivers in your projections.
- Growth: Please describe key assumptions. How does it compare to expected market growth? Where will it come from (increase in price, increase in volume, increase in market share, new products, acquisitions, etc.)?
- Margins: Please describe key assumptions. Why (for example) do you expect margins to increase so significantly compared to historical performance? Where will it come from (operating leverage, cost efficiencies, higher margins on products, revenue/cost mix, etc.)?
- KPIs: Describe key assumptions. How do they compare to the industry average and/or your main competitors?
- What are the primary risks to this forecast (new product introduction, successful expansion into new geography, customer concentration, sufficient hiring of employees, R&D resources, etc.)?
Legal
- Material contracts: Look at past and current material contracts. This includes the debt structure, acquisitions and other liabilities, and it may include key customer, partner or supplier agreements.
- Property, plant and equipment: Consider the company’s property, plant and equipment to study its assets and liabilities. One example of this is a detailed review of key operating or capital leases.
- Human resources: Assess the target company’s management team, employees, and compensation structure. Look at employment terms/agreements, individual contracts, collectively bargained agreements, and retention/severance agreements. In conjunction, a review of the management and employees are necessary.
- Health and welfare plans: Review the health benefit plans, retiree health plans, and retirement plans to understand any regulations or legal issues surrounding the benefits.
- Information technology: Look at software or hardware agreements with external parties, contractually obligated product features or service level agreements, license agreements, and other technology agreements.
- Lawsuits/litigation/patents:Look at the company’s lawsuits/litigation provides a summary of any pending litigation, history of past litigations, and what may arise in the company, such as environmental, employment, customer or worker compensation issues.
- Environmental: Understand any potential liabilities the business is exposed to in its environment while conducting the day-to-day processes, such as hazardous material or toxic waste.