The first step of any private equity investment—deciding where to invest—might seem obvious, but it’s not easy to execute.
Strong private equity returns, after all, stem from a complex choreography that includes finding great businesses, acquiring them for value and driving operational improvement prior to exit.
A key part of screening potential investments, then, is assessing the business quality of a particular company. Our experience tells us that great companies consistently produce cash flows that are durable and stable over the long term. While countless factors contribute to business quality, we have found that six specific attributes come together (and overlap) to mark a good or great company, regardless of sector or geographic location.
Once we have screened companies for these attributes, we take an opportunistic approach to find situations where we might be able to acquire such high-quality businesses for value. We also look for opportunities where taking on an active operational role would likely enhance the performance and cash flows of the businesses.
Here, we take a closer look at these six attributes, including the importance of each, and share the questions we ask ourselves in determining whether a business is one we might want to own.
The Six Attributes of a Great Business
Essential products or services
High barriers to entry
Stable cash flows
Durable competitive advantages
Large-scale operating leverage
When we describe the quality of a business, we are summarizing a wide range of characteristics that determine its long-term chances of success.
As part of our underwriting, we perform a thorough analysis of company-specific financial and operating performance, as well as a detailed review of industry structure and competitive market dynamics. This allows us to assess trends in and drivers of operating performance. We also evaluate the magnitude and sustainability of a company’s competitive advantages, as well as the risks related to any possible changes in a company’s product, service or value proposition. We then translate that into our assessment of long-term cash flows and value creation potential. This comprehensive bottom-up analysis allows us to build conviction in the businesses we seek to invest in—high-quality businesses in sectors we know well and where we have a competitive or informational advantage—and supports our objective of creating value through our hold period.