Principal of Bass Creek Advisors
Principles of Private Equity Fundraising: Differentiating Your Firm

Principles of Private Equity Fundraising: Differentiating Your Firm

With thousands of small middle-market private equity buyout firms in the market to raise funds, differentiating your firm is critical.

1. Due diligence

Any successful private equity firm requires rigorous due diligence practices. To stand out from competitors, firms need to figure out how they can demonstrate the quality of their due diligence and the results it has produced. It’s not enough to just describe the process—metrics are necessary. For example, how did projections for portfolio companies in market studies and investment write-ups compare with their actual performance? Firms which compare quality of earnings reports from before acquisition to post-acquisition results can demonstrate that serious surprises are infrequent. Giving an actual number and scale to a limited number of surprises shows that the firm’s due diligence is spot-on. The firm should also show how any surprises feed back into improvements in its due diligence process. Investors also want to hear why a firm may have abandoned a deal or made price adjustments after due diligence; these details speak to a firm’s judgment.

2. Sector focus

Firms often focus on one particular business sector or a small handful of different sectors. Investors want to know that the firm has an advantage in terms of sector knowledge, relationships, and connections that can help source, evaluate, and close excellent deals. Ultimately, firms need to explain why they have a focus and what advantage it offers to potential investors. Often, firms have a specialist board of advisors for a particular sector. Be sure to clarify how the board has been created and prove its value in evaluating and closing deals, using numbers wherever possible. This can be a significant differentiator.

3. Management assessments

Today, private equity firms frequently partner with third-party management assessment firms that evaluate the executive staff of potential acquisitions. These assessments focus on the executive’s background, business acumen, motivation, and willingness to learn. Firms that use these services should draw a line in the sand in terms of which assessment grades are acceptable, which are not, and why. Many investors will also want to know that the deal team has spent time with management—at a variety of levels. Interfacing with management across the organization provides visibility into a company and reveals whether company leaders have a shared vision. It also sheds light on company culture and whether the view at the top is shared by the rank and file.

4. Deal sourcing

One of the key metrics that investors use to evaluate private equity firms is deal sourcing. Funds should have up-to-date metrics on the number of deals they see on an annual basis, as well as hit rate for Indications of Interest (IoI), management visits, and Letters of Intent (LoI). Comparing these numbers to industry averages can provide important context and help firms build an argument for the value of their particular processes. Investors may want to know about any unique incentives for deal sources and the steps that funds take to build and maintain relationships with these sources. Many funds have dedicated a lot of time to building key relationships. Demonstrate how this work has paid off in terms of the number of quality deals you see from a wide set of sources. Tracking pricing wins and losses across the spectrum of IoIs and LoIs is also useful.

5. Investment decision-making

Investors will want to know the decision-making process for investments, as well as the internal dynamic. This process is at the heart of what private equity firms do and should be clearly explained to investors. Firms should describe the type of information provided to decision makers at each stage, from Indication of Interest to due diligence review and prior to the ultimate decision. Each firm likely has a different process in terms of who weighs in at each stage, and this information is important for investors. For example, some firms allow team members working on a deal to advocate for it but not to vote in the final investment committee decision. Others give deal team members a vote. Investors may ask to attend deal review meetings to observe firsthand how decisions are made. At the heart of this factor is what criteria are used to proceed or not with a transaction. Stories and case studies on this issue help articulate the investment culture.

6. 100-day plans

The majority of funds will work with the management team of a portfolio company to create a plan for the first 100 days after the investment closes. Often, this plan includes the installation of reporting regimes and initiatives to refine marketing approaches. These plans need to include actionable items, not just big-picture goals. Investors will want to see results after that 100-day period has ended. Firms should be able to show that the plans are taken seriously and executed to the fullest extent possible. This helps demonstrate the operational capacity of the firm.