How Private Equity Firms Find Great Businesses
5 Key Factors Private Equity Investors Look For
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, Last Updated :
Feb 24, 2025
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Every businessperson has, at some point, asked themselves: what makes a good business? This question is even more critical for private equity (PE) investors, who commit billions of dollars — often leveraged with even more debt — into acquiring and scaling businesses.
In this article, we’ll explore the five key factors PE investors analyze when evaluating potential investments. Before diving in, try to think of a few yourself and see if you guessed correctly.
One of the most important factors PE investors consider is the size and growth potential of a company’s total addressable market (TAM). A great business operating in a shrinking market is unlikely to be a good investment, no matter how well-run it is.
For example, in 2012, a PE firm might have come across a highly profitable cable provider. However, given the rise of streaming services, that company would likely struggle long-term due to declining market demand. Conversely, a well-positioned electric battery manufacturer today could grow exponentially as the electric vehicle (EV) market expands.
Beyond just market size, investors assess how well the company is positioned to serve it. Questions they seek to answer include:
How large and fast-growing is the market?
What market share does the company currently hold, and how much can it realistically capture?
Who are the target customers, and what are their buying behaviors?
What is the company’s go-to-market strategy, and how effective is it?
How will economic shifts, technological advances, or disruptions impact the industry?
2. Competitive Moat
A sustainable competitive advantage — or “moat” — is non-negotiable for PE firms when evaluating an investment. A company’s moat protects it from competitors and ensures long-term profitability. It can take many forms, such as brand strength, proprietary technology, cost advantages, or network effects.
A lack of a moat leaves a business vulnerable. Take BlackBerry as an example. In 2009, the company had a dominant 20% share of the smartphone market. However, Apple and Android quickly eroded its position, revealing that BlackBerry lacked a durable competitive edge.
To assess a company's moat, PE investors analyze:
Who are the primary competitors, and how intense is the competition?
Does the company have a cost advantage, proprietary technology, or unique differentiators?
How strong is its brand recognition, and in what regions does it dominate?
Additionally, investors often use frameworks like Porter’s Five Forces to evaluate industry dynamics, supplier and buyer power, and barriers to entry.
3. Financial Profile
PE firms don’t just look for profitable companies; they focus on businesses that fit a specific financial profile, distinct from venture capital or hedge fund investments. Given PE firms' reliance on leverage (debt) to acquire businesses, they prioritize companies with:
Stable Cash Flows: Predictable revenue streams are crucial to ensuring the company can meet operating expenses and debt obligations.
High Free Cash Flow (FCF) Conversion: The ability to efficiently turn revenue into cash is essential for reinvestment and debt servicing.
Low Capital Intensity: Businesses requiring minimal capital expenditures to scale tend to be more attractive as they generate higher profitability.
PE firms conduct deep financial due diligence, analyzing revenue growth, pricing trends, and margins across product lines and geographies. These insights help build robust operating models and leveraged buyout (LBO) projections to assess potential returns and risk.
4. Scalability & Unit Economics
A business with strong unit economics signals scalability and profitability. Unit economics measure the direct revenue and cost associated with a single unit of a product or service.
Consider Shopify. The company’s unit economics are exceptional because it generates increasing revenue per merchant through additional services, while onboarding new merchants adds little incremental cost. Retention is also high since switching platforms is inconvenient.
In contrast, WeWork had poor unit economics. Revenue per location was relatively fixed due to competitive rent prices, while scaling required costly real estate investments. Additionally, customer stickiness was low, as businesses could easily cancel leases.
To assess unit economics, PE investors evaluate:
What is the company’s unique value proposition?
How sticky is the product, and what are churn rates?
Are there opportunities to increase revenue per customer over time?
What are the fixed versus variable costs, and how do margins evolve with scale?
5. Management Team
Behind every successful company is a strong management team. No matter how good a business looks on paper, an ineffective leadership team will ultimately drive it to failure.
PE investors conduct rigorous management evaluations, including in-person meetings and continuous interactions throughout the due diligence process. Key questions include:
What are the company’s competitive advantages, opportunities, and threats?
How well does the management team understand the industry and growth potential?
What are the strengths and weaknesses of the leadership team?
What is their vision for operations, growth, and strategy?
If a management team is deemed capable and aligned with the PE firm’s objectives, they may be retained post-acquisition. Otherwise, PE firms often replace leadership, including the CEO, to ensure better execution.
Bonus: Exit Strategy
Even if a business checks all the boxes, it must have a clear exit path. PE firms invest with the goal of selling the company — whether through M&A or an IPO — within a set timeframe. Without a viable exit, there are no returns to be realized.
Final Thoughts
Understanding these five key factors — TAM, competitive moat, financial profile, unit economics, and management quality — gives you insight into how private equity firms evaluate investments. However, the job of a PE professional goes beyond just analysis—it requires executing deals, working closely with portfolio companies to drive growth, and ultimately delivering strong returns to investors. Successful PE investors combine financial acumen with strategic thinking and operational expertise to create long-term value.
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