Different Types of Investors Focus on Different Metrics

Key Takeaways:
  • Private equity, family office and individual investors prioritize different valuation metrics based on their investment strategies and goals.
  • Key business valuation metrics like cash flow, EBITDA and growth rates are essential, but industry-specific factors, such as patents or subscription-based models, can significantly influence investment decisions.
  • Specializing in certain industries allows investors to achieve economies of scale and set realistic ROI targets by leveraging complementary capabilities within their portfolios.

 

When investors examine a business valuation, they typically look at a range of key metrics to assess the company’s financial health, growth potential and overall value. But the metrics that interest them most often depend on the investors’ long-range goals and reasons for considering a business acquisition. What may be a pivotal metric for one investor may not matter much to another. 

While investors – and their checkbooks – come in all shapes and sizes, three general types of investor groups dominate the landscape in the Midwest: 

  • Private equity (PE) groups typically look for investments of more than $25 million, possibly with an additional fundraising option for the right company. Private equity investors usually commit to a four- to six-year investment strategy, holding the company until it reaches a more mature stage, then selling it.  
  • Individual investors may seek investments of $1 million or more, and typically plan on being active investor-owners, as opposed to PE groups and family office investors, who are passive owners. 

Business Valuation Metrics 

The valuation metrics that most investors consider to be key indicators of quality include revenue; net income; cash flow; earnings before interest, taxes, depreciation and amortization (EBITDA); growth rates; debt-to-equity ratio; return on investment; and market share. 

But there are many other factors that professional valuators can include in a valuation that clearly tell the story of a business’s success, depending on the company’s industry, its products or services and its business lifecycle stage (startup, mezzanine or mature). 

Private equity investors generally want to know they’re going to receive some capital appreciation in stock, as well as potential dividends, during the holding period. So, while they may be willing to invest in startups or young companies, they will look for valuation metrics such as strong cash flow, recurring revenues and a good growth trajectory. 

While a PE group or family office investor may invest in a pre-revenue startup, they will be particularly focused on businesses that have products or concepts that can be scaled and gain market share quickly. They are willing to wait to get their return on investment (ROI) on the back end, but only if they are confident that a startup company’s management, products or services and go-to-market approach are solid. 

This group will also look at potential quality of earnings in a valuation. How will the startup make its money? In the technology industry, single sales of software have largely given way to subscription-based revenue models, much to the delight of investors. Subscriptions mean recurring revenues, repeat customers and solid cash flow. 

Intangible factors are another valuation metric that matter in certain industries. For instance, in the biomedical and medical device industries, patents and FDA approvals can make the difference between a highly successful investment and one that goes flat.  

Even if patents and regulatory approvals are not yet in place, PE investors who are more risk-friendly often are looking to get in on the ground floor of a startup business, so intangible metrics like technologies that are patent-pending and which have broad applications are particularly attractive. The investors will put together projections about when the products or services will go to market, what anticipated revenues will be, the number of subscribers or customers that will be needed to hit revenue targets and what the forecasted cash flows will be. 

Specialization 

Whether the investors are a PE group looking for a $25 million-plus investment or an individual seeking a $2 million local company to acquire and turn around, many investors hone their focus on certain industries. This way, they can build expertise in an industry and set aggressive yet realistic goals for their ROI.  

Moreover, a PE group or family office that owns several companies in a specific industry can achieve economies of scale by matching up complementary capabilities in their portfolio companies and sell products or services to a larger group of customers. Industries that are often the focus of specialization include manufacturing, distribution, technology, pharmaceuticals, biomed and biotechnology. 

A recent survey of PE investors found that they expect general business conditions to improve in the next year, and they plan to target their investments predominantly in the business services (31%) and manufacturing (27%) industries. Other industries that will capture PE investments include wholesale and distribution (9%), consumer goods and services (9%), healthcare and biotech (8%) and construction and engineering (6%). 

If you would like to know more about parsing the key metrics in a business valuation that would help you zero in on a promising investment, contact an Adams Brown valuation specialist.