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Investing in earlier-stage businesses is a bit like dating. You weigh what’s exciting and what’s important to you against what doesn’t work for either side. And if you walk away, it doesn’t mean your date’s wrong and you’re right. It simply means both sides are looking for a partner to fulfill distinct needs and this match doesn’t meet them.
Private equity firms are just as varied. They seek to invest at different criteria and levels of capital, and they prioritize different variables and categories for an array of reasons. Some won’t write a check smaller than $100 million, while others focus on alignment to their original investment thesis.
Related: A Beginner’s Guide to Private Equity
For us, we are looking for disruptive, mission-based businesses that are seeking capital to drive scale, along with dramatic revenue and EBITDA growth. Our firm looks to deploy initial capital in the $12-25 million range, with a focus on media, entertainment, healthcare and wellness businesses.
Attracting our attention, like most P/E firms, involves more than, “Here’s my great idea, here’s my three-year forecast, invest in me.” Given the stage in which we invest, we’re typically the first institutional investor a business will encounter. There’s a lot to be learned from how we vet prospects. Here are some reasons why we’ll walk away from the opportunity to invest:
We receive roughly 20–30 proposals a month, many unsolicited. They run between five and 70 pages (shorter ones are often stronger and more specific), outlining the elements of the business, revenue, management teams, EBITDA, and what the firm sees as opportunities for growth.
Some proposals promise enormous growth or “hockey stick” projections. They might cite worldwide addressable markets or trends in the category — even though those variables don’t directly relate to their business. Or their forecasts are backed by undefined or undisciplined variables and vague circumstances.
An investment proposal is your first date and it needs be sharp, tight and deeply reflective of the values of the founders. We’re looking for partners who are open, humble, collaborative and informed. If you ask what keeps them up at night, and the collection of answers is canned or vague, we’ll move along pretty quickly.
Taking money off the table
It’s not uncommon to encounter a founder who hopes to sell equity for a part of their business and put some, or all, of the proceeds into their own pockets as a reward for their hard work. Our response: Good luck. This is not to suggest they don’t deserve the payout. But for us, this is neither a good use for our investor’s capital nor good alignment for our partnership. Furthermore, it indicates the founder may have different priorities for the company’s growth.
We want to put our cash to work with management teams who are hungry for success and agree with us on a successful exit. We want to make sure the investment goes into the business, and then bet together that the capital materially accelerates the company’s growth and profitability. If the founders are to remain, they must be focused, aggressive and in lockstep with what we both hope to do within an agreed timeline.
The industry is too heated
Five years ago, we invested in music publishing. Our thesis was that music streaming would hit globally and drive growth and value in a slumping category. We jumped in and made significant investments. But others were seeing the same things we were. Valuations crept up quickly and value as a buyer diminished over time.
The music publishing business is still a good long-term investment, but for us it’s very difficult to get a good return on our investment with a 5–7-year timeline. The category will likely return to better value but we will be on the investment sidelines until it does.
We’ve often told people that their business is just too early. They may not have quite figured out their core consumer proposition or financial systems are not adequate, or their EBITDA is just too far from profitability. But this needn’t be a death knell.
I encourage anyone who’s been told no to shake it off and treat rejection professionally, as they would any other disappointment. One company called again five years later after we declined to invest, saying it had done what we had previously suggested, and asking for another look. We invested within weeks of the call.
We’ve also seen founders become upset — even slamming down the phone when they’ve received disappointing news. We understand and empathize with their disappointment. But that response isn’t productive and doesn’t help their future proposals. Our advice is to listen and decide whether they want to address the suggested obstacles that are preventing them from getting the capital they need.
Check size matters
Taking a cautious approach to smaller investments is prudent for one reason: A $2 million deal takes the same amount of work — or more — as one for $20 million. We are in the business of putting capital to work and must review the opportunity as a return on time and effort in addition to return on investment.
It must be worth our time to undertake a thorough due diligence process. Think about it this way: No one feels sorry for private equity when an investment goes astray. We are on the hook, both professionally and reputationally. Our due diligence is likely more exacting than a company receiving its first institutional capital has ever experienced.
We need to understand the client base, the margins and unit economics, the systems, projections and potential pitfalls, then verify it all. The process essentially becomes a full-time job for the CFO, and much of the management team. The opportunity must be sizable enough to provide a return not just on the capital but on the time investment as well.
In the courting process, it’s vital to align our capital expectations with both of our due diligence time and efforts.
The litigation showstopper
Any litigation underway is a red flag, especially conflict involving partners. It’s best to disclose everything from the outset and walk us through it. Try to hide it, and we’re going to find it. We’ve killed deals late in the game due to discoveries like these. If you’re not upfront and transparent from the beginning, then you’re not the right partner for us.
Timing is everything
I love meeting founders, hearing their passion, enthusiasm and, most of all, their personal journeys. Even if we don’t ultimately invest, it’s a joy to talk to someone who has built a business from the ground up and really understands the mechanics, obstacles and opportunities in their business.
But what doesn’t work for us at that moment may make perfect sense for another P/E firm — or us — later in the company’s journey. In the dating world, timing is everything. The same is true for private equity investment partnerships.