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Questions to Ask a Private Equity Firm

  • How to tease out the underlying dynamic of a private equity fund
  • What questions you should ask PE firms to determine which is the right fit

Private equity can be a great path for founders looking to either bring on a partner to help scale their company, accelerate growth by adding capital to the balance sheet, or pull liquidity from the business.

If your company has made waves in its industry, private equity or "PE" firms will often find you before you find them. PE firms in the tech space commonly have robust outbound business sourcing programs dedicated to calling and emailing founders to build relationships and generate proprietary deal flow.

While receiving phone calls and emails from PE firms can open the door for you to begin evaluating your various M&A/investment options, not every firm will be a good fit for your company. Private equity investors aren’t just expert investors, they’re also phenomenal salespeople, bent on marketing themselves as the right partner for your company. As a founder, you’ll need to look past the marketing to understand the true dynamics of the fund, particularly as you consider a long-term partnership.

Asking the right questions early can help you spend time with the firms that will truly set themselves apart and be the right eventual partner for your business. Below are 9 questions we help our clients get answers to before partnering with any private equity firm.

Note that for many of these questions there are no universally right or wrong answers. What works in one relationship between firm and founder won’t necessarily work in another. Rather, the goal in asking these questions is to determine how well a given firm’s goals and investment strategy align with your own.

9 Questions to Ask Every Private Equity Firm

1) How large is your fund?

The size of a private equity firm’s fund relative to the size of the proposed investment in your company will influence how much attention the firm’s partners will devote to your company.

For example, if a PE firm has a multibillion dollar fund and your deal size is relatively small, then your company will likely receive much less attention from the firm. Board meetings may be less frequent, with partners less likely to make an appearance at each one. In addition, strategic resources to help grow your business may be less readily available.

On the other hand, if your deal size would make up a significant portion of the fund, then you can expect a lot more attention, which may or may not be what you’re looking for. This attention can take the form of increased data reporting requirements, more frequent board meetings/discussions, regular update calls with the PE partner, and a potential quicker trigger on executive replacement if performance is suboptimal, among other things.

Additionally, if an investment in your company would be one of the firm’s largest deals, being able to write the final check could be more difficult, increasing the risk of the deal not closing.

In many cases, a private equity fund will list its typical check size on their website. Use that information to get a sense of whether or not your company is a good fit.

2) What is your target return profile and strategy?

In asking this question, you’re trying to understand how quickly the PE firm expects you to grow your business. Your goals for the company and your personal economics as a founder should be aligned with the investor’s stance on risk.

For example, if you intend to take a large portion of liquidity out of the business while capturing future upside on rollover equity, you may be less concerned about risk and better aligned with an aggressive investor.

If, however, you prefer to retain a majority stake and are looking to bring on a minority investor to grow the business at a moderate rate, then you would be better aligned with a less aggressive investor.

The higher the typical return profile, the higher the risk. Most private equity firms will seek a 3-5x return profile, but there do exist value-focused, debt-oriented funds who are content with more modest returns of 2-3x. VC funds will be looking for 5x+ returns and are therefore looking to increase the risk profile across their portfolio and hope for one company to cover the costs of all the others.

Something to note is that the higher a firm’s expected return, the more willing they are to pay a premium for the asset. For example, a firm with an aggressive strategy looking for a 5x return will be more willing to up the ante during negotiations than the value-based firm seeking a 2x return.

No strategy is better universally, just individually depending on the nature of the company pursuing investment.

3) What role will you play in the relationship during and after the transaction?

The private equity representative you work with entering a transaction isn’t necessarily going to be part of the transaction team assigned to your company or the partner sitting on your board. As we previously mentioned, many PE firms have a robust outbound program designed purely to manage deal flow, and in some cases individuals in a biz dev function have no role working with portfolio companies post-transaction.

While each firm varies in how it structures its myriad internal functions, what you as a founder need to tease out is who specifically you will be working with in the long-term. When you get into the thick of a transaction, the private equity firm is going to assign a transaction team to work with your company. Try to connect with that team early and develop a relationship with them directly. Ensure the team has someone from the firm whose role is VP or above so you're getting the proper attention.

The most important member on that team will be your future partner—the person who will sit on your board. Work to determine if that future partner’s personality aligns well with your own personality and your company’s strategy. Also pay attention to whether or not the partner is a senior or junior partner. Doing so will set you up for the best possible outcome with the right firm and partner.

4) How many investments will the partner have active at one time?

When a partner joins your board, you won’t have them all to yourself, as partners oversee the performance of multiple portfolio companies at a time. Before you get to that point, you’ll want to determine how much bandwidth they’ll have so you can continue the conversation with eyes wide open.

If a partner’s attention is divided between 10 or more portfolio companies, you can expect that you won’t get much of their time. If you’re 1 of 5, the partner’s availability will be much more open.

5) What is the typical board composition?

Getting a sense of a board’s composition will help founders understand how much influence the firm/partner will exert over the company’s high-level strategy.

Typically, board representation is commensurate with how much of the company each member owns. However, depending on how the board is structured, some partners will be more involved and/or heavy-handed than others.

Some specific questions to ask include:

  • How many members of the private equity firm will sit on the board?
  • Are voting rights dependent on ownership or do partners have special voting rights?
  • Will the board have a third-party, independent member? If so, who will recommend and approve that member?
  • How actively involved will the partners be on the board?
  • How often will the board meet?

With each question, the more involved the firm is in board meetings, the more influential they will be on the firm’s overall strategic direction.

6) What experience do you have resolving _______ issue?

In most cases, founders who are raising capital (other than for liquidity) are looking to make progress in a specific area of their business, such as sales & marketing. The right private equity firm/partner will be able to help define the strategy in that given area as well as invest the capital to execute that strategy.

7) What experience do you have in my sector?

If your partner is unaware of common challenges or patterns in your industry, you could find yourself having some difficult board discussions. When selecting a firm and partner, you want someone who understands the end market dynamics. Otherwise, the partner’s skills will be less applicable as a resource in the context of your end market.

8) What do the first 100 days look like after the deal closes?

Getting a sense of the first 100 days post-transaction will help you better understand the timeline for change and the dynamic of the long-term relationship so you can make the most informed decision possible.

On one end of the spectrum, a partner may be so hands off that once the deal closes, the company continues business as usual. On the other hand, the firm may become highly involved, enacting internal and external initiatives to:

  • Improve specific business functions like sales or marketing
  • Standardize performance reporting and analysis
  • Seek to recruit new management to fill gaps or replace current team members
  • Put all CEOs through a mentoring or executive management program
  • Optimize the company's capital structure through new or restructured debt
  • Update and/or build a detailed operating and financial model
  • Implement a new employee option plan and determine equity grants
  • Leverage their network of existing and former portfolio companies for potential partnership opportunities
  • Begin building an M&A pipeline, if they intend to pursue a rollup strategy

Neither approach is better, but one or the other (or somewhere in between) will be more aligned with your desires and expectations as a founder. The more aligned, the better.

9) How do you view M&A as a strategy?

Many firms use M&A as an inorganic growth strategy, meaning that the firm uses a combination of the fund’s capital and bank debt to buy up related companies and integrate them into their portfolio companies.

Inorganic growth may or may not match your company’s current strategy. If your company has experience integrating acquisitions, then a PE firm that prioritizes inorganic growth may be the right fit and provide a shorter timeline to the second exit. Otherwise, you may want to focus on firms that can help you grow organically with operational expertise and internal investments.

Be aware that PE firms who employ a growth-through-M&A strategy could significantly dilute your ownership as a founder. Because M&A-led growth is capital-intensive, the private equity firm must put up additional primary capital to fund the acquisitions, diluting the founder’s ownership. Over the course of a few years, the PE firm could end up owning a majority of the company, even if the founder owned the majority at the time of the initial investment.

Ask for References and Hire an Investment Bank

As institutional investors, private equity firms have been around the block a few more times than founders. As such, they’re very skilled at marketing themselves as the right fit, even if the underlying dynamic doesn’t quite line up.

For founders who don’t have years of M&A experience to see past the marketing and correctly profile a private equity firm’s position, there are two primary ways to ensure they’re finding the right fit:

  1. Ask for references. While a private equity firm will paint the best possible picture of their relationships with portfolio companies, managers of portfolio companies will be more candid about their experience working with a given firm or partner.
  2. Hire an investment bank. An investment bank with direct experience working with the various firms/partners will provide a wealth of insight into whether or not a given firm is the right fit for your company. They’ll be able to help you get answers to your questions and see through to the substance of a firm so you can make a more informed decision. Having an investment bank on your side is especially important if you intend to run a competitive transaction, as keeping track of 15+ firms while also running a business can be challenging.

Learn more about why you should hire an investment bank and the importance of hiring an unconflicted advisor to run your M&A or capital raise transaction.

Modified on Jun 10, 2021