What Private Equity Investors Want: 5 Metrics
Private equity funds are numbers driven. One of the first things they do when they purchase a business or make a big investment is to expand the business’s information systems. This helps the new ownership figure out which products are selling and where the costs really are. It almost always identifies where the company’s cash flow is coming from (and going). Private equity managers view this “professionalization” of a company’s systems as something that will help it sell your company to the next larger, more sophisticated financial buyer.
Before digging into the details of your current information system, the buyers will want to meet with with you. This might be the first big sitdown after you’ve cashed your check and gone on your long-overdue vacation. Here’s what they’ll want to discuss.
Cash flow Although net income is important (no one wants to own a business that isn’t making money), private equity managers are fixated on cash flow. They value businesses on EBITDA (earnings before interest, taxes, depreciation, and amortization). That’s the number they’re looking to boost and the one they’ll analyze most closely. Increased EBITDA is what’s going to allow them to eventually sell your business for more than they paid you.
Liquidity Your controller, bookkeeper, or chief financial officer (if you had one) was probably managing your company’s liquidity needs, balancing any seasonality in your business with credit availability. Liquidity is going to become more of an issue, because the private equity fund probably used some leverage to buy your company. Private equity managers will want weekly, monthly, and quarterly cash flow models (perhaps even daily in a crisis) to make sure your company stays within the liquidity covenants negotiated with its lenders. It’s impossible to predict liquidity needs perfectly, but modeling helps avoid crises.
Product-by-product analysis Cost accounting can be tricky in complex companies, and small firms can often lose track of where they are really making profits and generating cash. Expect a product-by-product analysis, with the goal of finding the true margins on each product. In service businesses, expect a focus on how contracts are bid and a particular emphasis on avoiding contracts that increase revenue but aren’t all that profitable.
Expense control Any new buyer will dig into current expenses, asking questions about your policies, why certain expenses have spiked, and how they are controlled.
Industry-specific metrics Each business will have its own key metrics—and they may surprise you. Often a good common-sense look by a new set of eyes (in this case, the private equity fund) will give you a better idea of which metrics you really should be concentrating on.
After your meeting, expect those metrics to matter. Metrics become the backbone of how the private equity fund thinks about the company—so be ready to embrace them. And if you feel any heartburn, just think about everything you can do with the rest of that big check.
ED POWERS | Columnist | Head of Capital Access Funds, Bank of America
Based in New York, Ed Powers is a managing director and head of the Capital Access Funds team at Bank of America Merrill Lynch. Capital Access Funds is an experienced, returns-driven private equity fund-of-funds.