How to build business plans to attract private equity funding

While there are many areas that NPs value, four are essential: 1. Target addressable market (TAM) and competitive position, 2. Revenue model, 3. Clearly superior leadership, and 4. Clarity on investment areas for promote growth.

NPs first focus on TAM and competitive position. The reason is probabilistic: Mediocre management can deliver superior results in a fast-growing market with manageable competition. Even the best managements struggle to deliver results in a tough market. PEs bet on growth markets with manageable competition.

The TAM should be specific and reflect a deep understanding of the market structure. For example, for a standalone Analytics player, simply saying the Analytics market is $150 billion is wrong. More than half of this market consists of hyper-scalers such as AWS (Amazon Web Services) and is not addressable. Likewise, if the business specializes in commercial data and analytics in pharma, then the addressable market is proportionally smaller. And if that market consists primarily of license fees paid to third-party data partners, the actual TAM is a fraction of $150 billion.

To access this TAM, it is important to identify the white spaces that can be protected. If the market position is not differentiated and protected by the gap, growth will be neither sustainable nor profitable. Getting the market structure, resulting TAM and competitive position is the first step.

Next, the revenue model becomes important. PE managers prefer predictable income for the next two to three years. They closely analyze recorded revenue, pipeline, conversion rates and key customer relationships. PE executives and their CDD (commercial due diligence) consultants spend about half their time on the revenue model. We have ways to independently validate the quality of key customer relationships and arrive at a risk-adjusted revenue projection.

Because of this consideration, it is advisable to build income plans that are grounded. Empty plans, such as those showing stagnation for the last three years followed by a magical growth after PE investment, are easily identified and affect credibility.

Further, having clearly superior senior leadership is an enviable gap. We have observed investors willing to pay a 15-20% premium to have such leadership.

Superior leaders have three characteristics: One, an internal understanding of market structure and competition, which leads to the rapid identification of growth levers and related actions. Second, a record of productive allocation of limited capital to the areas producing the highest profits. Three, an ability to simplify and communicate strategy to the larger organization and deliver results through middle-level management. While these parameters are qualitative, I can guarantee that such superior leaders are rare but not difficult to identify. And often, they are the company’s top salespeople.

Note: We often see companies that have delivered superior results in recent years using one or two superior leaders. While this may seem like a positive, it is a red flag. Superior leadership is extremely difficult to scale. Instead, it is the depth of leadership and his ability to make the most of available resources that matters.

Finally, clarity about how PE money will be distributed is important. NPs want maximum income and it is encouraging if investment areas have already been identified. An analytics firm that recently raised PE funding knew that hiring strong account managers for its key clients would drive rapid growth. The NPS (Net Promoter Score) with these customers was high, but they were not being cultivated adequately. Conversely, it is a red flag if a significant portion is allocated to pay existing shareholders. Processes and quality also matter, but these are considered easier solutions. Of course, attracting and retaining talent can be a stumbling block in hot markets and this needs to be addressed.

It is important to think like a PE when building business plans.

Abhisek Mukherjee is co-founder and director of Auctus Advisors

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