Here’s a real-world example of the investment strategy used by an extremely successful private equity firm — one that claims it has completed $27 billion of leveraged transactions and other private equity investments involving 450 properties since being founded in 1989. That averages out to over $1 billion and 20 properties (companies) per year!
“Our investment criteria are highly consistent. We seek high quality companies led by motivated and skilled executives who want to own as well as run their businesses. We have successfully executed this strategy in several sectors; however, regardless of the market being served, our portfolio companies exhibit certain specific characteristics:
- High barriers to competitive entry
- Predictable, recurring revenues such as subscription businesses with high customer retention rates
- High operating leverage whereby moderate increases in company revenues can yield even more rapid increases in operating profit
- Opportunity to significantly increase profitability through revenue growth, consolidation of expenses, add-on acquisitions leading to efficiencies of scale, or other operating improvements”
This pithy statement does a wonderful job of articulating the importance of early and strong revenues as per our earlier posts.
Two other aspects that venture capitalists usually mention are market size and the management team.
Although market size targets vary, it is common to hear a desire for the addressable market to be in the hundreds of millions of dollars. This may sound excessive, but consider that 10% share of a billion-dollar market is $100 million — a size to which VCs would typically like to see their portfolio companies grow.
We’ll save a detailed discussion for a future post, but savvy investors realise that the composition of the management team is key. Start-ups need someone who has vision and sound judgement, someone who can quickly develop the product, and someone who can sell. Proven expertise in these areas is a critical success factor.