Training · PE-1 · Lesson 02 of 08
Investment criteria
The rule
Before a deal is modelled, it has to pass a filter. Funds write their criteria down so that sourcing, not just analysis, is disciplined.
Why criteria exist
A firm sees hundreds of opportunities a year and invests in a handful. Written criteria let the team reject quickly and spend time where returns are plausible. Most firms publish a version on their website; the internal version is stricter.
Business quality
Firms look for companies that will still be good in ten years regardless of who owns them.
- ·Leading or defensible market position.
- ·Recurring or repeat revenue with diversified customers.
- ·Stable or expanding margins, pricing power.
- ·Low capital intensity and manageable working capital.
- ·Limited exposure to technological or regulatory disruption.
Financial capacity for leverage
Lenders size debt as a multiple of EBITDA, and the company must service it from free cash flow. Firms check interest coverage, fixed-charge coverage and cash conversion. A business with 90% cash conversion can carry far more debt than one with 50%.
- EBITDA
- $80m
- Leverage at 5.0x
- $400m debt
- Interest at 8%
- $32m
- Capex + taxes
- $25m
- Free cash after interest
- $23m
- Interest coverage (EBITDA/interest)
- 2.5x
Management and value-creation plan
Sponsors back management teams or bring in new ones. They ask whether the team can deliver the plan, whether incentives align (management typically rolls equity and receives options), and what specific levers the firm will pull: pricing, procurement, add-on acquisitions, geographic expansion, digital investment.
Exit visibility
Before investing, a firm wants to know who could buy the company in five years. Multiple potential buyers — strategics, larger sponsors, public markets — support exit value. If only one buyer exists, there is no competition and no reliable exit multiple.
Hold onto this
- ·Market leadership, recurring cash flow, low capital intensity, and room to improve operations.
- ·Multiple exits matters: a company only saleable to one buyer has no auction.
- ·Ask what the fund will actually do to the business that management has not already done.
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Education, not financial advice. Figures may be simplified for illustration.