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What Private Equity Looks for Before Buying a Business

ExitClarity · April 1, 2026 · 3 min read

How Private Equity Evaluates Acquisition Targets

Private equity firms in the lower middle market — those targeting businesses with $5M to $50M in enterprise value — run a consistent evaluation framework. Understanding that framework is one of the most useful things an owner can do to prepare for a sale process.

This isn't about gaming the evaluation. It's about knowing what questions are coming and making sure your business can answer them credibly.

The Core Criteria

EBITDA and Margin Quality

PE firms start with the financials. They will recast your EBITDA — stripping out non-recurring items, owner compensation, personal expenses, and anything else that won't transfer to the new owner — to arrive at an adjusted, normalized number.

What they're looking for: consistent EBITDA over 2–3 years, clean add-backs that can be documented and defended, and margins that are stable or improving. Declining margins or a single spike year raise immediate questions.

Revenue Quality and Predictability

Not all revenue is equal. PE firms assign higher value to contracted or subscription revenue, recurring revenue with documented renewal rates, and revenue distributed across a broad customer base. They discount project-based, relationship-dependent, or owner-driven revenue.

Customer Concentration

A single customer representing more than 15–20% of revenue is a material risk. If that customer leaves post-acquisition, the deal math changes significantly. PE firms will either discount heavily for concentration risk or walk away.

Owner Dependency

This is one of the most common deal killers in the lower middle market. If the business runs through the owner — if key customer relationships, institutional knowledge, or operational decisions require owner involvement — buyers will question whether the business can perform post-close.

The standard PE question: What happens to this business if the owner is removed on day one?

Management Team

PE firms are not buying a job. They're buying an organization. A capable, retained management team that can execute independently is a significant value driver. The absence of one is a risk that gets priced in.

Market Position and Competitive Dynamics

PE firms favor businesses with defensible market positions — specialized capabilities, proprietary processes, geographic dominance, or customer switching costs. Competing on price in a commoditized segment is a red flag.

Growth Runway

PE firms buy with a thesis — they need to believe they can grow the business over a 4–7 year hold period. Owners who can articulate a credible growth story are more attractive than those who present a stable but static business.

What PE Firms Find in Due Diligence

The most common issues that surface in PE due diligence — and compress value or kill deals:

• Financial statements that don't reconcile cleanly
• Revenue tied to personal relationships that can't be transferred
• Undisclosed liabilities or deferred expenses
• Key employee agreements that don't exist or can't be enforced
• IP ownership that isn't clearly documented or assigned to the company
• Customer contracts that are verbal or can be terminated without notice

See also: exit readiness factors, how businesses are valued, and how to prepare for a sale.