There are more than 30 million small and medium-sized businesses (SMBs) in the United States, all of which support more than 60 million employees, either directly or indirectly through employment, supply chain, business functions, etc. The businesses are crucial to the growth of the economy, as they employ just shy of half of the private workforce within the US. Despite their significance in the economy, not all small and medium-sized businesses (SMBs) are owned by larger parent companies, nor are most of them owned by investors.

According to a report by Pitchbook, private equity firms invested roughly $130 billion in SMBs last year. PE firms are increasingly interested in small and medium-sized businesses (SMBs) because of their promising growth and ability to “roll up” with other businesses to create a larger organization inorganically. Though many small and medium-sized enterprises (SMBs) would benefit from private equity investment, not all would, because many aren’t operating at the necessary margins, and not all leaders have a vision that wants to be a market leader in their industry.

The most important factors that private equity firms look for in small and medium-sized businesses are as follows:

Private equity investors can be enticed by a dependable financial reporting system. Small and medium-sized businesses (SMBs) need to pay special attention to the creation of reliable financial reports such as balance sheets, income statements, and cash flow statements. The initial way that PE firms determine whether an SMB is a valid candidate is by digging through its financials, and if these are too messy or don’t exist, it is often representative of a myriad of other issues. 

Streamlining business processes (sales, service/product fulfillment) is a key factor in helping small and medium-sized enterprises become more productive and lucrative, both highly sought-after factors. This can be accomplished by staying lean in all processes, computerizing previously manual tasks (hello, Chat-GPT and Zapier), and cutting down on unnecessary hires. A firm grasp of supply chain management and its effects on net profits is also crucial, which is often ignored in the SMB ecosystem due to an over-prioritization on revenue.

A strong market position is essential for small and medium-sized businesses to appeal to these private equity firms, because if not, they would rather acquire the company next door with a favorable position, all things considered. Among these are familiarity with the intended audience, an original selling point that is differentiated from competitors, and proven success (often represented in the form of revenue and years in business). In addition, small and medium-sized businesses should work on strengthening their brand recognition and expanding their customer base, since it is a lot easier for an investor to take the business from 40 states to 50 than from 3 to 20.

When considering an acquisition, private equity firms place a premium on a company's leadership, as well as the founders and the vision they have held on to. Focusing on building a strong leadership team that can carry out the company's strategy and oversee expansion should be a top priority for small and medium-sized enterprises, and if this team isn’t prioritized, they will bring in industry experts through us that know how to turn a company doing well into something fantastic. This involves doing things such as ensuring key employees are invested in the company's future and that there is a well-defined plan for who will take over if someone leaves. Revenue shares, equity ownership, and succession plans are some of the easiest ways to incentivize owners and executives.

PE firms seek out projects with scalability as a priority, since the goal is to grow and make their investors more money, their goal is to gain profitability and scale. Small and medium-sized enterprises (SMEs) need to prioritize the creation of a scalable business model that takes into account infrastructure, technology, and processes. When the time is right, this will allow the company to rapidly expand (a reason why software companies are so valuable).

SMBs must follow all applicable legal and regulatory requirements. This involves doing things like giving workers adequate training on compliance policies and establishing a reliable system for managing contracts. There is nothing that kills a deal faster than when compliance is messy, and a lot of violations are taking place.

The bottom line is that SMBs can improve their chances of attracting private equity investment by concentrating on these central points. This is the best way for these businesses to ensure their continued success and expansion over the long term: to be in peak condition for growth, profitability, and scalability.