Private equity investment involves providing funding directly to a private company. Before investing in a company that is not public, investors must do a great deal of due diligence and consider a wide range of factors. These factors relate to the growth potential for the company, its leadership, and its ability to generate returns. All of these influence the decision to invest, as well as the nuances of the deal behind the investment. If any red flags are identified during the due diligence phase, the investment agreement should address these issues to provide some level of protection for the investor and/or the deal should be terminated.

Read on to understand some of the factors that potential investors should think about before signing or even drafting an investment contract.


1. Financials

Investors need to have a clear sense of a company’s financials before offering additional money. Ideally, you should be able to see the financials going back at least five years (or since the company’s inception if it is younger than that). Important documents to obtain include balance sheets, income statements, and cash-flow statements. If you don’t have a strong financial background, you may want to have a finance expert review this paperwork, especially since strong balance sheets do not necessarily speak to the future viability of a company.

Another key part of financial health is short- and long-term debt, as well as the terms behind them. If the company does not have the cash, cash flow, or assets to cover short-term debts, it may be an indicator that the company could fold sooner rather than later. A company’s ability to cover long-term debt largely depends on profit projections, so it is important to make sure that these obligations are not overwhelming.


2. Market

Even a great company with an excellent product can still fail without the proper market. You should have a clear sense of the current market size and trends to see if the company you want to invest in has a clear place in it. Trends can be economic, demographic, regulatory, and geographic, among other relevant factors. Understanding these trends can help you envision how the company can address new needs in the market. Sometimes, companies have a strategic plan for building a market, so it is important to consider this information too.

The market analysis also needs to look at current and potential competitors. Even if no competitors currently exist, it is important to consider what the competition might look like down the line to be sure the company is prepared to shift position and adjust appropriately.


3. Business model

Investing in a company without a clear business model or one that is not clearly understood can prove disastrous. You should know how the company will make money and trust the management team to make good decisions. Often, it pays to speak directly to all the top managers at the company to figure out their philosophies and think about any problems that could arise in terms of leadership or personalities.

Company leaders should be decisive and confident. Plus, they should have a strategic plan for growth in the future. Importantly, the plan needs to build in flexibility to account for potential changes in the market while still laying out a clear path toward company goals. If the goals of the company or the path toward them are not evident, ask why.


4. Operations

The concept of an operations review and deep dive is critical. You will need to have a clear idea of how the company operates daily, from sales and marketing to cash management. Companies should devote enough time and money to sales and marketing to allow for growth without sacrificing product development and other processes.

You may also want to get a sense of how the company handles human resources, from how and who they hire to the policies they’ve created for current employees. Some startups adopt seemingly radical policies that can lead to employee satisfaction and drive productivity. Before investing, get a sense of how much energy is devoted to following the market and developing products, including what is done with feedback from customers.


5. Customers

Speaking of customers, one of the most important things to look at before investing that is often overlooked is customer satisfaction. Not all companies will have a large customer base, but it is important to look at their reaction to the organization as a whole. Customer satisfaction surveys and reviews are a good place to start but it is also critical to do actual customer interviews.

For more established companies, pay close attention to customer retention. When companies have a large number of returning customers, it signals that the company treats them right. Companies should have their own internal reports on customer satisfaction. Beyond that, looking at blogs, third-party review websites, and the Better Business Bureau can add more dimension to the internal reports. As mentioned, you can also speak directly to customers. Ideally, there is evidence that the company is actively responding to customer feedback.