November 30, 2022
How you should build business plans to attract private equity funds

How you should build business plans to attract private equity funds

Away from the glamour of unicorns, there are thousands of leaders building businesses the old-fashioned way, painstakingly and profitably. In India, a large proportion of these are services businesses. Likewise, most serious private equity (PE) firms are ignoring the hype and looking for businesses that can grow fast, but sustainably and profitably. This column explains how services businesses can build plans to attract PE investments.

While there are many areas that PEs evaluate, four are crucial: 1. The Target Addressable Market (TAM) and competitive position, 2. The revenue model, 3. A demonstrably superior leadership and 4. Clarity on the investment areas to drive growth.

PEs first focus on TAM and competitive position. The reason is probabilistic: A 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.

TAM must be specific and reflect a deep understanding of the market structure. For example, for a standalone Analytics player, just saying that the Analytics market is $150 billion is incorrect. More than half this market comprises of hyper-scalers like AWS (Amazon Web Services) and is not addressable. Likewise, if the business specializes on commercial data and analytics in pharma, then the addressable market is proportionately smaller. And if this market comprises largely of licence fees paid to third-party data partners, the actual TAM is a fraction of the $150 billion.

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

Next, the revenue model becomes important. PE leaders prefer predictable revenues for the next two to three years. They closely analyse signed-up revenue, pipeline, conversion rates and key client relationships. PE leaders 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 client relationships and arrive at a risk-adjusted revenue projection.

Because of this scrutiny, it is advisable to build revenue plans which are grounded. Hollow plans, like ones that show stagnation for the past three years followed by magical growth post PE investment are easily identified and impacts credibility.

Next, having a demonstrably superior top leadership is an enviable moat. We have observed investors willing to pay 15-20% premium to access such leadership.

Superior leaders have three characteristics: One, a visceral understanding of the market structure and competition, leading to quick identification of growth levers and associated action. Two, a track-record of productive allocation of limited capital to areas that produce the highest returns. Three, an ability to simplify and communicate strategy to the larger organization and deliver results through an average middle management. While these parameters are qualitative, I can vouch that such superior leaders are rare but not difficult to identify. And often, they are the company’s top salespersons.

Caveat: We often see companies which have delivered superior results in recent years by leveraging one or two superior leaders. While this may look like a positive, it is a red flag. Superior leadership is notoriously difficult to scale. Instead, the depth of leadership, and its ability to make the most of available resources, is what matters.

Finally, clarity around how the PE money will be deployed is important. PEs want maximum returns, and it is encouraging if the investment areas are already identified. An Analytics firm which recently raised PE funds knew that hiring strong account managers for its key clients would drive growth fast. The NPS (Net Promoter Scores) with these clients were high, but these were not being farmed adequately. Conversely, it is a red flag if a significant proportion is allocated to pay off existing shareholders. Processes and quality also matter, but these are considered easier solves. Of course, attracting and retaining talent can be a deal-breaker in hot markets and this must be addressed.

It is important to think like PEs while building business plans.

Abhisek Mukherjee is the co-founder and director of Auctus Advisors

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