Michael Tait, independent chairman and non executive director, explains the basics of how a private equity firm will select an investment.

Private equity firms follow a rigorous process for selecting investments. Here are the steps they typically take:

Deal sourcing: Private equity firms rely on a variety of sources to find investment opportunities, including investment banks, business brokers, industry contacts, and proprietary research. They also actively seek out potential investments by attending industry conferences and events, and by directly approaching potential targets. Almost certainly the introductions come via an M&A advisor who will have prepared an investment proposal on behalf of the investee company.

Screening and evaluation: Once a potential investment opportunity is identified, the private equity firm will conduct a preliminary screening to assess its fit with the firm’s investment criteria. This may involve reviewing financial and operational data, interviewing management, and assessing the competitive landscape.

Due diligence: If the potential investment passes the initial screening, the private equity firm will conduct a more in-depth due diligence process to evaluate the company’s financial, legal, and operational performance. This may involve reviewing financial statements, contracts, and legal documents, as well as conducting market research and site visits.

Valuation: After completing due diligence, the private equity firm will determine the fair market value of the investment. This may involve using a variety of valuation methodologies, such as discounted cash flow analysis or comparable company analysis.

Deal structuring: Once the investment is valued, the private equity firm will negotiate the terms of the investment with the company’s management and owners. This may involve determining the amount and type of financing, the level of control the private equity firm will have, and the expected returns.

Execution: If the private equity firm and the company’s owners reach an agreement on the terms of the investment, the deal will be executed. This may involve acquiring a controlling or non-controlling stake in the company, and may involve additional financing from other sources.

Value creation: After the investment is made, the private equity firm will work closely with the company’s management to implement operational and financial improvements, with the goal of increasing the company’s value over the investment holding period.

Overall, private equity firms follow a disciplined process for selecting investments, including deal sourcing, screening and evaluation, due diligence, valuation, deal structuring, execution, and value creation. By following this process, private equity firms are able to identify and invest in high-quality companies with strong growth potential.

Michael Tait’s article about M&A advisers

British Venture Capital Association Guide