When it comes to measuring business growth and tracking key performance indicators, the majority of investment banks and private equity firms devote the brunt of their focus to the bottom of the funnel. It's only natural to want to place an emphasis on closing deals that are right in front of you, rather than those on the horizon. However, in the big picture, that's a myopic view that fails to account for the fact that it likely takes reviewing dozens, if not hundreds, of prospective businesses to get that right one to the bottom of the funnel.
The top of the deal sourcing funnel is where the magic happens. It's where you review, compare, and contrast hundreds of investment opportunities to find the most suitable target for your investment strategy. Simply put, an increased number of deal opportunities reviewed leads to both higher quality prospects and an increased number of deals closed. With that in mind, there are a few key indicators of business performance you should be aware of. By effectively monitoring these performance metrics in an M&A platform, you enhance your deal sourcing efforts and identify the optimal targets.
Deal origination revolves around the question, "Is this a quality investment opportunity?" Typically, there are several metrics that a private equity firm or investment bank will look at to assess business performance, including:
Cash Flow - The majority of larger investments often involve the investor taking on a substantial amount of debt. As a result, the investor must know whether or not the target investment will be able to:
Nothing else matters if the business can't create the necessary cash flow. High cash flow is a crucial signifier that the business is healthy, growing, and likely to keep flourishing - all portents of a smart investment.
Revenue - This is crucial as it gives you the most reliable overview metric of:
When analyzing revenue, your goal is to identify whether the business is properly positioned to increase revenue and at what rate they'll (potentially) do so. Naturally, the goal is to find a business whose revenue growth rate is in proportion with other key metrics. Revenue growth that drastically outpaces capacity could be a warning of an impending slowdown or decrease.
EBITDA & EBITDA Margin - Earning before interest, tax, depreciation, and amortization will grow in a steady upward trajectory as opposed to a volatile trend. Revenue is meaningless if it's all being spent back on costs. A key growth indicator for small businesses and big businesses alike are solid EBITDA margins with comfortable levels of cash flow on hand.
Debt - Like EBITDA, debt will heavily influence cash flow. A surplus of debt results in all capital being devoted to paying back interest and principal payments, leaving smaller possible returns for prospective investors. It's helpful to gauge this by comparing the company's debt leverage ratio to the industry as a whole. Although some debt is necessary for growth, too much is a problem and a key indicator that growth may be slower (or inhibited). That said, a high ratio isn't necessarily a deal-killer if you know that the company is generating enough cash flow to pay off debt and provide cash coverage for investors.
Employee Numbers - A steady rate of new employees or an employee hike in conjunction with investment infusions are all positive indicators of a healthily growing company. For founder-owned or institutionally-backed businesses who don't usually post their revenue or EBITDA publicly, this is an excellent substitute for inferring viability of the business.
Job Postings - Notwithstanding currently counts of employees, an increase or decrease in job postings acts as an excellent leading indicators, especially for Venture Capitalists who invest particularly in the future potential of a business, whereas Private Equity or Growth Equity firms are more commonly interested in the current value of an asset.
In the past, finding accurate estimates for private business' KPIs was no easy feat. Finding basic details on growth rate and other measures of business success was a time-consuming affair that often produced incomplete or out-of-date information. With Sourcescrub, however, unlocking many of these critical performance indicators is simple. This powerful deal origination platform can discover and track investment opportunities on your behalf, rendering it easy to find accurate private company information and firmographics. From helping with how to research market trends to providing up-to-date specifics on company data, the tools you need all exist in one platform.
If your analysts are tired of relying on manual list scrubbing or word of mouth to procure pertinent business performance metrics, it's time to make your strategy smarter with Sourcescrub. By utilizing our innovative technology, you will have greater success in achieving your deal flow goals by equipping your team with consistently accurate and easily accessible data on companies across industries.
1. King, S. GrowthForce. Free Cash Flow- What Does It Mean for Business Growth?
2. Parson, H. EY. The New Imperatives for Deal Origination. (2019).
3. McClure, B. Investopedia. A Clear Look at EBITDA.