Private equity players determine their investment criteria through a systematic evaluation of fund size, expertise, risk appetite and return objectives. These criteria act as a filter for potential investments and include financial thresholds, sector specialisation, geographical focus and management evaluation. The process combines quantitative analysis with qualitative assessments to achieve optimal portfolio composition.
What are investment criteria and why are they crucial for private equity parties?
Investment criteria are predefined parameters that private equity funds use to evaluate and select investment opportunities. These criteria minimise risk by applying consistent evaluation methods and maximise returns by focusing on companies with proven value creation potential.
The criteria arise from the fund strategy and are set out in the investment memorandum. They determine which deals reach the investment committee and avoid wasting time and resources on unsuitable opportunities. Without clear criteria, arbitrary deal flow evaluation arises that undermines return objectives.
Institutional investors expect transparent investment guidelines in line with their own risk appetite. Private equity parties also use these criteria for reporting to limited partners on portfolio strategy and investment decisions.
How do private equity funds determine their ideal company size and sector focus?
Private equity funds determine company size by dividing their fund volume by the target number of investments, typically investing 15-25% of the fund per deal. Sector focus arises from the management team's expertise and proven track record in specific industries.
Fund size dictates the minimum and maximum deal size. A €200 million fund usually targets companies with enterprise values between €50-150 million. Smaller funds focus on the mid-market segment, while mega-funds target large corporates.
Sector specialisation offers competitive advantages through in-depth market knowledge, relevant network and proven value creation methods. Specialised funds can structure more complex deals and implement operational improvements that generalists lack.
Geographical focus correlates with local market knowledge, regulatory expertise and operational network. Dutch funds have advantages in domestic deals due to cultural understanding and established relationships with advisers and financiers.
Which financial ratios are decisive for private equity investments?
EBITDA growth, profit margins and cash flow stability are at the core of financial evaluation. Private equity players use sector-specific benchmarks where IT companies justify multiples above 10x EBITDA, while industrial companies are valued between 5-7x EBITDA.
Revenue growth should be consistent and predictable, preferably driven by structural market trends rather than cyclical factors. Recurring revenue is rated higher than project-based revenue because of predictability and lower customer concentration risks.
Working capital management demonstrates operational efficiency. Companies with negative working capital cycles generate more free cash flow and require less growth capital. This increases the return potential for private equity investors.
Debt capacity is assessed through debt-to-EBITDA ratios and interest coverage. The financing structure should fit the business model and strategic horizon, where too much leverage can limit growth or reduce strategic agility.
Why is the management team so important in private equity investment decisions?
The management team determines the feasibility of value creation planning and operational improvements. Private equity parties invest in people who can turn strategic visions into measurable results within the investment horizon of 3-7 years.
Track record in similar situations outweighs general management experience. Proven performance in scaling up, international expansion or operational transformations gives confidence in future execution under private equity ownership.
Cultural fit between management and fund prevents conflicts over strategic direction and operational priorities. Successful partnerships require alignment on growth ambitions, risk tolerance and exit timing.
Incentivisation through management equity creates conflicts of interest. Managers with substantial equity investment show commitment to value creation and accept higher performance standards that support private equity return targets.
How does exit strategy influence private equity parties' investment criteria?
Exit opportunities determine maximum realisable value and therefore fundamentally influence investment criteria. Trade sales to strategic buyers justify higher entry multiples than IPO scenarios because of synergy premiums and faster exit processes.
Market conditions for exits vary by sector and economic cycle. Private equity parties adjust criteria based on M&A activity, stock market sentiment and availability of strategic buyers in target sectors. An active M&A market justifies more aggressive investment criteria.
Secondary buyout opportunities are becoming increasingly important as an exit route. Companies need to remain attractive to other private equity parties, which places demands on size, professionalism and further scalability potential.
Exit-timing flexibility reduces pressure selling risks. Investment criteria should select companies that can exploit different exit windows without value destruction through forced sales in adverse market conditions.
What due diligence aspects ultimately determine the investment decision?
Commercial due diligence Validates market positioning, competitive advantages and growth assumptions that underpin the investment case. Financial due diligence confirms quality of earnings, working capital normalisation and cash flow predictability that feed valuation models.
Legal due diligence identifies deal-breaking risks such as pending litigation, regulatory compliance issues or contractual restrictions that limit operational flexibility. These findings can subsequently tighten investment criteria or eliminate deals.
Operational due diligence assesses implementability of value creation planning. Management capabilities, IT systems, operational processes and organisational readiness determine whether theoretical improvements are practically realisable within the investment horizon.
ESG due diligence gains increasing importance due to institutional investor requirements. Environmental liabilities, social compliance and governance structures influence both risk profile and exit opportunities, especially in trade sales to listed strategic buyers.
Integrating these due diligence findings into final investment decisions requires experienced assessment of risk-return trade-offs. Professional guidance from specialised corporate finance advisers helps navigate complex transaction structures and optimise investment terms. For strategic decision-making on private equity partnerships or exit preparation, please contact for a confidential discussion of your specific situation.
Link copied!
