Crafting A Compelling Private Equity Investment Case

Private equity firms are investment management companies that specialise in making investments in privately held companies or in public companies that they plan to take private. They raise capital from investors, including pension funds, endowments, and high-net-worth individuals, to launch private equity funds, which they operate as general partners.

The private equity case study is an important part of the private equity recruitment process, as it allows firms to evaluate a candidate's analytical, investing, and presentation abilities. A well-crafted investment thesis is paramount in this process, as it guides direct deal sourcing efforts and enables firms to differentiate themselves in a competitive market.

This article will outline the steps to writing an investment case for private equity, including understanding the goal of the acquisition, creating a framework, developing a hypothesis, building support for a recommendation, and delivering a recommendation.

Understanding the goal of the acquisition

• Potential for growth: Private equity firms may target companies with strong growth potential, including the potential to expand into new markets, introduce new products or services, or increase market share in existing markets. They may also seek to improve operational efficiency and profitability by specialising in operational optimisation.
• Strategic fit: Private equity firms may pursue investments that align with their overall investment thesis or strategic objectives, including investing in companies that complement their existing portfolio or fill gaps in industry coverage.
• Turnaround opportunities: Private equity firms may specialise in turning around distressed companies facing financial challenges, acquiring them at a discounted price.
• Market timing: Private equity firms may invest in companies based on market conditions, lower-than-average valuation multiples, or industry trends, such as during economic downturns or industry consolidation.

When understanding the goal of the acquisition, it is also important to consider the basic parameters of the deal, such as the overall available capital and company demographics (e.g. location, size, and industry). Additionally, it is crucial to identify both the internal and external factors influencing the deal. Internal factors may include what the firm hopes to gain from the deal, such as bridging a valuation gap in the portfolio. External factors could include socioeconomic or industry trends that make the investment type attractive.

Creating a framework

A good framework will make solving any private equity case interview easier. An incomplete or poorly thought-out framework will make the process more challenging. While it is not recommended to memorise frameworks, there is a single framework that can be applied to almost any private equity case interview. The major components of a private equity framework could include:

• Market attractiveness: What is the market size and growth rate of the market that the acquisition target is in? How competitive is the market?
• Company attractiveness: What is the financial performance of the acquisition target? What are their key strengths and competitive advantages? What are their weaknesses?
• Private equity firm capabilities: Does the private equity firm have expertise in the industry or market that the acquisition target is in? Does the firm have the capabilities or resources to improve the company's performance?
• Synergies: Are there potential revenue or cost synergies that can be realised with other companies in the private equity firm's portfolio?
• Financial implications: Is the acquisition price fair? What is the potential return on investment? How long will it take the private equity firm to recoup their initial investment?
• Risks: What are the major risks of this investment? Can these risks be mitigated? What is the likelihood of these risks materialising?

When creating a framework, it is important to keep in mind the specific details and nuances of the case. The framework should be customised accordingly.

For example, a top-down investment thesis for a venture capital firm could be: "This $10 million seed fund focuses on US-based cannabis startups that are furthering the industry through technology and infrastructure research and development, leveraging our partners' vast experience in logistics and supply chain sectors." This statement is succinct yet comprehensive and serves as a guiding principle for the firm's investments.

Once a firm has identified a company that fits its top-down thesis, it is time to create a bottom-up version. A bottom-up investment thesis is more direct and specific, including financial statements, future business plans, funding strategy reasoning, industry trends, and why the firm is the best choice.

To create an effective framework, it is essential to answer a series of questions, such as:

• What is the goal of this thesis?
• What are the basic parameters of the ideal deal, such as overall available capital and company demographics?
• What are the influencing internal and external factors?
• Why your firm?
• Why this deal?

By answering these questions, you can develop a robust framework that will guide your investment thesis and ensure all necessary information is included.

Developing a hypothesis

To develop a strong hypothesis, you should consider the following:

• Market Attractiveness: Evaluate the market size, growth rate, and competitiveness of the industry in which the target company operates. Is it an attractive market for potential investment?
• Company Attractiveness: Assess the financial performance, strengths, weaknesses, and competitive advantage of the target company. How attractive is this company as a potential acquisition?
• Private Equity Firm Capabilities: Does the private equity firm possess the industry expertise and resources necessary to improve the target company's performance? Can they add value through operational improvements or strategic guidance?
• Synergies: Are there potential revenue or cost synergies that can be realised by acquiring this company? Are there complementary businesses within the private equity firm's existing portfolio that could benefit from this acquisition?
• Financial Implications: Is the asking price for the company fair and reasonable? What is the potential return on investment, and how long will it take to recoup the initial investment?
• Risks: What are the major risks associated with this investment? Are these risks manageable and mitigable? What is the likelihood of these risks materialising?

When developing your hypothesis, it is essential to strike a balance between confidence and flexibility. While you should have a clear direction, be open to adjusting your hypothesis as you gather more information and insights throughout the case interview process.

Remember, your hypothesis will serve as a foundation for your analysis and recommendations. A well-developed hypothesis will demonstrate your ability to think critically, solve complex problems, and make informed decisions—all of which are highly valued skills in the private equity industry.

Building support for a recommendation

Building support for your recommendation is a crucial step in writing a compelling investment case for private equity. Here are some key points to consider:

• Market Attractiveness: Evaluate the market size, growth rate, and competitiveness of the industry in which the acquisition target operates. Is it a growing industry with attractive prospects? How does the company's market position and performance compare to its competitors?
• Company Attractiveness: Assess the financial performance, strengths, and weaknesses of the target company. Look at their historical and projected growth, profitability, customer and product diversity, differentiating factors, and management capabilities.
• Private Equity Firm Capabilities: Analyse whether your private equity firm has the necessary expertise and resources to improve the target company's performance. Do you have specific industry knowledge or capabilities that can add value?
• Synergies: Identify potential revenue and cost synergies by integrating the target company with other companies in your portfolio. Are there opportunities for cross-selling, economies of scale, or operational efficiencies?
• Financial Implications: Evaluate the fairness of the acquisition price and the potential return on investment. Consider the expected timeline for recouping the investment and the potential exit strategies, such as a strategic sale, IPO, or secondary buyout.
• Risks and Mitigation: Identify the major risks associated with the investment, including market, competitive, and execution risks. Develop a risk mitigation plan and discuss the likelihood of these risks materialising.
• Due Diligence: Conduct a thorough due diligence process by analysing financial statements, future business plans, industry trends, and the target company's competitive advantages. Look for unique selling points and assess how the acquisition aligns with your firm's investment thesis.
• Qualitative and Quantitative Analysis: Support your recommendation with both qualitative discussions and quantitative data. Use case math and financial modelling to back up your arguments, but also provide insights into the company's qualitative factors, such as management capabilities, industry trends, and potential synergies.
• Exit Strategy: Clearly articulate the exit strategy and timeline for generating a suitable return on investment. Consider potential buyers, growth strategies, and the company's ability to handle additional debt.
• Sensitivity Analysis: Conduct a robust sensitivity analysis to assess the impact of changes in key variables like revenue growth, EBITDA margins, or exit multiples. Demonstrate a thorough risk assessment and show how different scenarios affect returns.

Delivering a recommendation

In the final stage of the private equity case interview, you will need to present your recommendation to the interviewer. This is your opportunity to showcase your analytical skills and investment judgment. Here are some key points to consider when delivering your recommendation:

• Start with your recommendation: Begin by clearly stating whether you recommend acquiring the company or passing on the investment opportunity. It is important to have conviction and make a decisive case.
• Provide supporting evidence: Explain the reasons and present evidence that supports your recommendation. Discuss the key factors that influenced your decision, such as growth potential, operational improvements, strategic fit, financial analysis, or exit strategy.
• Address potential risks: Identify and address any potential risks or challenges associated with the investment. Show that you have considered different scenarios and developed a well-rounded understanding of the opportunity.
• Suggest next steps: Discuss what additional steps you would take if given more time or resources. This demonstrates your ability to think ahead and your commitment to the investment process.
• Structure your presentation: Organise your presentation to make it clear and concise. Start with your recommendation, followed by supporting evidence, and end by summarising your key points. Ensure your presentation is supported by data and financial models, but avoid overly complicated slides or excessive use of charts and graphs.
• Exercise business judgment: Demonstrate your ability to make informed decisions by considering the potential risks and rewards of the investment. Show that you can balance analytical skills with business acumen.
• Be prepared for questions: Expect follow-up questions and challenges from the interviewer. This is an opportunity to showcase your knowledge and critical thinking skills. Anticipate potential questions and have well-thought-out responses.
• Maintain a holistic perspective: Remember that private equity firms look for candidates who can analyse investments from a holistic perspective. Consider not only the financial aspects but also the strategic fit, market conditions, and potential value creation opportunities.
• Customise your recommendation: Tailor your recommendation to the specific private equity firm you are interviewing with. Showcase your understanding of their investment thesis, strategies, and areas of focus.
• Practice and refine: Practice your presentation and refine your messaging. Seek feedback from peers or mentors to improve your delivery and address any gaps in your analysis.
• Show your enthusiasm: Demonstrate your enthusiasm for the opportunity and your interest in the private equity industry. Show that you are passionate about the work and committed to pursuing a career in private equity.

Remember that the recommendation stage is your chance to showcase your ability to think critically, analyse complex information, and make informed investment decisions. Utilise the knowledge you have gained throughout the case interview process and present a well-structured and compelling recommendation.

Frequently asked questions