Tim's Two Cents

Third business characteristic

 3. "Recurring Revenue”

Firms love predictability.  Similar to the note on consistent earnings in last week's post, if your revenue numbers make for easy Excel model creation, firms notice.

The question is the relative stability and growth potential of revenue.  In private equity’s mind, one type of revenue stream is clearly more valuable.  I refer to recurring revenue versus project-driven non-recurring revenue streams.

 Typical recurring-revenue-stream companies include:

• Phone, utility and water companies
• Manufacturing companies with targeted niches
• Call centers
• Internet-based subscription service companies
• Software companies with annual licenses

Typical project or non-recurring-revenue-stream companies include:

• Engineering firms
• Contract manufacturing ; which characterizes most printing companies
• Construction firms

The recurring revenue model offers a high degree of revenue stability; however, revenues are generally harder to grow.  On the other hand, project-driven revenue is generated by one’s ability to win projects – with an emphasis on pricing and quality.   Sound familiar?  Project driven revenue by its very nature results in revenue fluctuations from month to month and year to year.  Nevertheless, it offers more of an opportunity to capture large chunks of business in a shorter time horizon. 

 

Second business characteristic many private equity firms look for in an investment

Profitability:

While some private equity firms look for turnarounds, most don't.  The more consistent your company's earnings, the better position you are in to attract the attention of investors.  The primary measure of profitability is usually EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization).  This is a measure of the company's operating cash flow.  Private equity is interested not only in the most recent EBITDA results, but also in the company's EBITDA trend.  An EBITDA trend that is up and to the right with good forward momentum will only help to increase value.  In other words, positive "Mo" brings "Mo."

Check back next week for the third characteristic.

 

Are you a candidate for private equity investment?

Warren Buffet famously states in Berkshire’s annual report that all he needs is five minutes before giving a yes or no on whether he’s interested in pursuing a transaction.  Not to discredit Mr. Buffet(whose patience and track record are another story), but his quick judgment is also shared by many private equity pros. 

Most firms plainly state in simple terms the types of businesses that interest them, and it doesn’t take much effort and analysis (or discussion) to determine if there’s a match. 

So does your business fit the general private equity acquisition profile for new platform investments?  Based on general observations perusing firm websites, and setting aside size, sector, and valuation considerations, I will share eight commonly business characteristics many private equity firms prefer.  Check back over the next eight weeks to see all of them.  The first one:

 1. “Strong management” 

Not sure why firms typically specify “strong” when it comes to management.  After all, who wants (or would admit they want) “incompetent” business leadership?  Bottom-line,  most private equity firms prefer management to come with the business.  They want passionate, motivated "thought leaders" who can deliver on what they promise.  Private equity invests in people and their ideas, not bricks and mortar.