By saying private equity deal killer, I mean some aspect of a deal that is too severe in risk and nature to allow the deal to continue. There are a few black and white private equity deal killers, but also many shades of grey.
We all have our own biases and this is especially true for the private equiteer who has sourced a deal. We look for reasons to do the deal and downplay the reasons not to.
The solution to this is to have a set list of deal killers and to stick to that list regardless. The problem of course is that you could miss great deals and there’s merit in looking at deals on a case-by-case basis. But I’m sticking by when in doubt, kill it, because you simply don’t need to take undue risk. The following list is not exhaustive, but outlines a few scenarios in which I’d kill a deal (and after all, there’s a rank and file in a private equity firm for a reason):
- Breach of investment mandate: a breach in mandate (industry, size, ethics, etc) is an instant deal killer. If arguments against this seem to be frequent, either there are issues with the mandate (which aren’t really issues, because it’s the mandate), or your team is just being argumentative.
- Existing market too small: the usual counter argument is that acquisitions can be made to increase the applicable market size. But, banking your investment on something as significant as an acquisition that may or may not occur is investment suicide in my opinion. There will always be risk in making investments, but why take much bigger risks when you don’t have to.
- Customer and/or supplier concentration: again, a potential acquisition may mitigate this, but you’re proposing to purchase the business now on its merits. Why pay for a business on the basis of risks being mitigated later, when you’ll have to do a lot of work afterwards to invoke the mitigating actions. If you’re willing to take those risks, then you should be paying less now.
- Industry concerns: if you’re proposing to enter an industry with fundamental issues or without adequate potential growth, then what are you really doing? Sure, you can reach target returns without market growth, but why take that risk when you don’t need to. Sometimes it’s just best to let a deal go than take undue risk.
- Management concerns: most importantly, if you don’t think you’re backing an excellent manager from the start, then I’d say that is a deal killer. Again, you can propose the argument that managers can be dumped, by why settle for second best? Private equity is firstly about backing a great manager, because they are the designated driver, so it really is unnecessary to take risks here.
I know I’ve been quite opinionated in this post and I concede that in a day, week or month, I may change my mind on some of these issues. But, I’ve witnessed a lot of self-fulfilling analysis lately and think it’s important to maintain objectivity in this climate. As the cliché says: lemons ripen early, plums ripen late. That is, if the deal looks like a lemon early, it probably is a lemon.