Private equity firms look for a company that throws off reliable cash, holds a defensible position in its market, has leaders worth backing, has room to grow meaningfully, and offers a believable path to resale in roughly five to seven years. What private equity firms look for in an investment is, at its core, a business they can buy largely with borrowed money, improve, and sell at a profit — which means every criterion ties back to protecting the debt and widening the eventual exit value. The capital typically comes from pension funds, endowments, and high-net-worth individuals, and 60 to 90 percent of the purchase price is usually financed with debt.
Predictable Cash Flow and Strong EBITDA
Financial performance is the first filter, and the metric that matters most is EBITDA: earnings before interest, taxes, depreciation, and amortization. It strips away financing and accounting choices to show how much cash the core business actually produces. The median purchase price for buyout deals reached 11.8 times EBITDA in 2025, with deals over $500 million averaging closer to 15.8 times over the prior five years.1McKinsey. Global Private Markets Report 2026 A company producing $10 million of annual EBITDA at an 11x multiple would be valued around $110 million.
Consistency matters more than raw size. Because so much of the deal is debt-financed, the buyer needs confidence the business can service interest year after year. Federal tax law caps the deductible portion of business interest expense at 30 percent of adjusted taxable income, so buyers favor targets whose earnings comfortably exceed debt service rather than companies pushed to the limit.2Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Low capital expenditure needs are a plus. A business that doesn’t have to keep buying expensive equipment retains more cash for paying down debt and funding growth.
A Defensible Competitive Position
A company’s moat — its protection against competitors — determines whether it can hold pricing power across a five-to-seven-year hold. Firms look for durable barriers: patented technology, trademarks registered under the Lanham Act, proprietary trade secrets, and deep customer relationships with high switching costs.3Office of the Law Revision Counsel. 35 U.S. Code 1 – Establishment
Pricing power is the clearest signal. A business that can raise prices without losing meaningful volume tells the buyer that customers have few alternatives. Switching costs reinforce that: when a customer is deeply integrated into a software platform or supply chain, moving to a rival hurts. Investors look for the evidence in gross margin stability. A company that holds high margins through an inflationary stretch is proving its moat under pressure.
Environmental, social, and governance factors increasingly fit into the same analysis. A target with weak data-privacy practices, questionable supply chains, or opaque governance carries regulatory and reputational risk that can erode value during the hold and narrow the eventual exit.
A Management Team Worth Backing
A buyer can restructure the balance sheet and set a new strategy, but the existing leadership has to deliver results day to day. Firms prioritize executives with a track record of hitting financial targets and managing transitions. Most deals require current leadership to stay on for several years, and a clear succession plan reduces the risk that losing one executive derails the investment.
To align incentives, executives are typically required to invest their own money alongside the firm. Restricted equity grants are a common tool, and executives often make a Section 83(b) election: they pay income tax on the stock’s value at grant rather than at vesting, so later appreciation is taxed at the long-term capital gains rate instead of as ordinary income.4Office of the Law Revision Counsel. 26 U.S. Code 83 – Property Transferred in Connection With Performance of Services The election has to be filed within 30 days of the transfer, and it cannot be revoked.
Non-competes protect the investment on the other side. When a firm pays a premium for a business, it needs assurance that founders and senior leaders won’t walk out and launch a rival. Non-competes tied to the sale of a business are generally enforceable, though state law varies on duration and geographic scope. The FTC finalized a federal rule in 2024 that would have broadly banned non-competes, but a federal court blocked it from taking effect and the agency later dropped its appeal.5Federal Trade Commission. FTC Announces Rule Banning Noncompetes Even under that blocked rule, non-competes signed as part of a good-faith business sale were explicitly exempt.
Room to Grow
Growth potential comes down to whether revenue can rise faster than costs. Firms want a large addressable market, with headroom for expansion through new products, new customer segments, or new geographies. The ambition is often to double or triple the business during the hold.
A buy-and-build strategy is one of the most common playbooks. The firm acquires a “platform” company and then uses it to roll up smaller competitors in a fragmented industry, capturing purchasing power, shared overhead, and cross-selling. Larger transactions trigger federal antitrust review under the Hart-Scott-Rodino Act, which as of February 2026 requires pre-closing filings for deals valued above $133.9 million.6Federal Trade Commission. New HSR Thresholds and Filing Fees for 2026 Standardized systems — technology platforms, reporting, and operating procedures — are prized because they can be replicated across each add-on acquisition.
A Credible Exit Path
Private equity invests on a defined timeline. Average holding periods now exceed six and a half years, with sectors like telecom and energy averaging closer to seven.1McKinsey. Global Private Markets Report 20267S&P Global Market Intelligence. Private Equity Buyouts Record Longer Holding Periods in 2025 Before writing a check, the firm identifies a realistic way to sell the business and return capital. A target with no plausible exit will usually be passed over regardless of its other qualities.
Common exit routes include:
- An initial public offering, where the company registers shares with the SEC. IPOs can produce the highest valuations but depend heavily on market conditions.
- A strategic sale to a larger corporation in the same industry.
- A secondary buyout, where another private equity firm acquires the business and pursues further improvements.
- A continuation fund, where the firm transfers the company into a new fund it manages. Continuation fund transactions reached an estimated $63 billion in volume in 2024.8CFA Institute. Continuation Funds: Ethics in Private Markets, Part I
Tax treatment at exit shapes the timing. Gains on a portfolio company held longer than one year are generally taxed at long-term capital gains rates, which top out at 20 percent.9Internal Revenue Service. Topic No. 409, Capital Gains and Losses A special rule applies to the fund managers’ share of profits, known as carried interest: it qualifies for long-term treatment only if the underlying assets were held more than three years, not the standard one-year period.10Internal Revenue Service. Section 1061 Reporting Guidance FAQs Short of three years, the gain is taxed at ordinary income rates up to 37 percent, and an additional 3.8 percent net investment income tax may apply.
What the Diligence and Deal Terms Will Test
Once a target clears the initial screen, firms spend 60 to 90 days verifying it. The centerpiece of financial review is a Quality of Earnings analysis, which adjusts for one-time events and normalizes revenue to establish a reliable earnings baseline. Buyers scrutinize at least three years of financial statements, tax returns, customer concentration, and accounts receivable aging, along with any audits or correspondence with tax authorities.
Legal diligence searches public records for liens, judgments, and litigation that could create post-closing liabilities. Standard checks cover UCC filings, federal and state tax liens, bankruptcy filings, and active lawsuits. Industry deals may add environmental, intellectual property, or regulatory searches. Anything unresolved becomes a negotiating point: a price cut, an indemnification clause, or a walk-away.
Deal terms then allocate risk after closing. An earn-out ties a portion of the purchase price to post-closing performance. Outside life sciences, the median earn-out has recently represented roughly 30 to 34 percent of the closing payment. Sellers tend to prefer revenue-based targets because revenue is harder to manipulate; buyers prefer EBITDA-based targets because they capture profitability. An indemnification escrow holds back part of the purchase price to cover breaches of the seller’s representations. Without representation-and-warranty insurance, the median escrow is roughly 9 percent of the purchase price with an 18-month survival period; with insurance, the escrow often drops below 1 percent and the survival period shortens to around 12 months.
Board Duties During a Sale
If the target has a board, its legal footing shifts once a sale becomes inevitable. Under Revlon, Inc. v. MacAndrews & Forbes Holdings, directors must then focus on getting the highest price reasonably available for shareholders rather than preserving independence or favoring a particular bidder.11Justia Case Law. Revlon, Inc. v. MacAndrews and Forbes Holdings, 1986, Delaware Supreme Court Decisions Private equity buyers structure their offers knowing a board that cuts off competing bids or plays favorites can face shareholder challenges.