Private Equity Deals: How Does a Fund Select Its Portfolio Companies?

$904 billion: that is the value reached by global buyout investments in 2025, representing a 44% increase over one year, according to Bain & Company’s *Private Equity Outlook 2026* report. At the same time, the number of transactions fell by 6%, to 3,018 deals. This trend shows that the market recovery has been concentrated in a smaller number of private equity deals, often large ones. Above all, it serves as a reminder that an abundance of capital never exempts funds from rigorous due diligence.

Before acquiring a stake, a private equity firm analyzes the company, its market, its management team, its financial results, and its growth prospects. It also seeks to determine whether the asking price leaves sufficient room for value creation, without basing its scenario on overly optimistic assumptions.

This process can take several weeks or even several months. It involves not only the investment teams but also industry experts, financial auditors, lawyers, and—depending on the target’s characteristics— specialists in technology, cybersecurity, or environmental, social, and governance issues.

What is a private equity deal?

A private equity deal refers to a transaction in which a fund acquires an equity stake in a privately held company. This stake may be a minority stake—in which case the management or existing shareholders retain control— or a majority stake, particularly in the context of a succession planning transaction.

The objective depends on the company’s stage of development. Venture capital funds finance young companies whose business models have yet to be established. Growth capital supports already-established companies that wish to accelerate their growth. Succession capital, often structured in the form of a LBO, facilitates a change in ownership of a mature company.

It is also important to distinguish between a “deal” and “deal flow.” The former refers to a specific transaction. The latter refersto all investment opportunities received, identified, and tracked by an investment management firm.

A club deal operates on yet another principle. It brings together several investors for a specific transaction, whereas a traditional fund generally builds a portfolio of multiple investments based on a predefined strategy.

How does the selection process for a private equity deal work?

The selection process is a step-by-step one. Each step serves to eliminate applications that do not align with the fund’s strategy or for which the potential return-to-risk ratio appears insufficient.

This process is not always perfectly linear. The valuation may change during the due diligence, while a newly identified risk may lead to a revision of the financial structure or to the suspension of negotiations.

How do funds identify investment opportunities?

Multi-channel sourcing

Opportunities may come from investment banks, M&A advisory firms, entrepreneurs, other funds, or the management company’s industry network. Some companies are presented as part ofa formal competitive process, while others are approached directly even though they are not officially for sale.

The sourcing process often begins several years before a potential acquisition. Teams monitor companies that are likely to align with their strategy, meet with their executives, and analyze trends in their market. This preparation enables them to make a decision more quickly when an opportunity arises.

The Importance of Proprietary Sourcing

Sourcing is referred to as “owner-led” when a management firm identifies and develops an opportunity outside of a highly competitive bidding process. A direct relationship with the executive can provide a better understanding of their project and help structure a transaction tailored to their needs.

However, this approach does not guarantee either a low price or the quality of the investment. Above all, it gives the fund more time to understand the company and present a distinctive industrial or strategic plan.

The Role of Sector Expertise

A specialized team understands a market’s key players, business models, and major risks. This enables it to more quickly identify a company with a competitive advantage or pinpoint weaknesses that a overly general analysis might overlook.

This expertise also facilitates post-acquisition support. A fund that understands the industry’s commercial, technological, and regulatory challenges is better positioned to engage with management and mobilize the appropriate resources.

How does the first filter work?

The first filter assesses whether a company is compatible with the fund’s strategy. Each fund has a mandate specifying the sectors, geographic regions, company sizes, type of investment sought, and the amount it can invest.

A company may have strong prospects but not be a good fit for the fund evaluating it. It may be too small, its business may be too cyclical, or its financing needs may be incompatible with the fund’s investment horizon.

The team typically prepares an initial memo outlining the business, the market, available financial performance data, key executives, the proposed valuation, and the main risks. At this stage, the goal is not to reach a definitive conclusion, but to determine whether the opportunity warrants further investment of time and resources.

The fund must also consider the composition of its existing portfolio. A new investment may appear attractive on its own but could result in excessive concentration in a particular sector, geographic region, or risk factor.

What criteria determine the quality of a target?

The market must offer sufficiently clear prospects

The fund analyzes the market’s size, growth rate, and structural drivers. A sector driven by digitalization, demographic shifts, or a long-term regulatory need can offer greater visibility than a market supported by a temporary trend.

This sector-specific growth is not enough. The team also analyzes the intensity of competition, barriers to entry, and customers’ bargaining power. A dynamic market may still be unattractive when competition exerts constant pressure on prices and margins.

The company’s unique positioning must then be established. The brand, technology, switching costs, service quality, or access to a distribution channel can all constitute competitive advantages, provided they can be sustained over several years.

The business model must be thoroughly understood

A clear business model makes it possible to identify the true drivers of revenue and profitability. The fund examines the recurring nature of revenue, customer loyalty, the ability to adjust prices, and the capital needed to finance growth.

The relevant metrics vary by industry. For a software company, the analysis will focus in particular on recurring revenue, retention rates, organic growth, and customer acquisition costs. For a manufacturing company, the focus will shift to production capacity, the supply chain, working capital requirements, and capital expenditures.

The fund thus seeks to distinguish between repeatable growth and growth driven by a few exceptional contracts or temporarily favorable market conditions.

The management team must be able to carry out the project

The quality of management is a key criterion in the selection of private equity deals. The fund evaluates the executives’ experience, how well their skills complement one another, their ability to make decisions, and their openness to a more structured governance model.

Particular attention is paid to the company’s dependence on its founder. When the founder controls business relationships, technical expertise, and key decisions, his or her potential departure can weaken the organization.

The fund also evaluates the depth of the team beyond the CEO. Having executives capable of managing finance, operations, sales, and technology reduces execution risk.

Alignment between shareholders and management rounds out this analysis. Incentive mechanisms can align executives with future value creation without undermining governance and oversight requirements.

Financial results must be reproducible

Financial analysis is not limited to the revenue andEBITDA reported by the seller. The fund seeks to understand the true economic quality of these results.

It analyzes the sources of growth, changes in prices and volumes, customer concentration, margins, investment needs, and the conversion of earnings into cash. High EBITDA that translates into low cash flow may indicate a greater-than-expected need for financing.

Forecasts are also compared with historical performance. A sudden discrepancy between past growth rates and future projections must be explained by concrete factors, such as new contracts, additional production capacity, or a geographic expansion that is already underway.

Value creation must be based on identifiable drivers

The fund must develop a value creation plan prior to the acquisition. This plan may be based on organic growth, international expansion, operational improvements, or the launch of new offerings.

External growth is another common strategy. A “buy and build” strategy involves using an initial company as a platform to acquire and then integrate complementary businesses. However, this approach requires a genuine ability to integrate and should not be used to mask insufficient organic growth.

Digital transformation, talent recruitment, and strengthening governance can also support development. In all cases, the necessary human and financial resources must be factored into the investment plan.

Value creation should not depend solely on debt or on reselling the business at a higher multiple.A robust scenario must be based on genuine improvement within the company.

What does the " due diligence " check?

The commercial " due diligence " tests the growth hypothesis

Market due diligence s assess market size, customer expectations, competitive advantages, and the credibility of the development plan. Interviews with customers, competitors, and experts can supplement the data provided by the company.

This analysis may reveal that seemingly solid growth depends on just a few customers or on uncertain regulatory developments. Conversely, it may confirm that the company has a market position that is difficult to replicate.

Financial " due diligence " measures the quality of results

The financial audit reviews historical financial statements, net debt, cash position, and working capital requirements. In particular, it seeks to calculate normalized EBITDA by excluding exceptional or nonrecurring items.

This step makes it possible to link accounting performance to actual cash flow generation. It may lead to a reassessment of the valuation or to negotiations for additional contractual protections.

Legal and tax analyses identify liabilities

Experts review commercial contracts, intellectual property, litigation, regulatory compliance, and tax risks. A dispute or reliance on a poorly drafted contract can profoundly alter the deal’s risk profile.

These conclusions may be incorporated into the purchase agreement through warranties, conditions precedent, or a price adjustment.

Operations and technology must support growth

Operational due diligence s analyzes the organization, processes, supply chain, human resources, and information systems. It seeks to determine whether the company has the necessary capabilities to carry out its plan.

Technology and cybersecurity are becoming increasingly important. Outdated infrastructure , poorly protected data, or excessive reliance on a single vendor may require significant investments after the closing.

ESG issues are analyzed based on their materiality

ESG due diligence s focuses on environmental, social, and governance issues that could affect the company. The analysis depends on the industry, the size of the target company, and its level of maturity.

For an industrial company, environmental risks and employee safety may be top priorities. For a digital company, data protection, energy consumption, and technology governance may become more pressing issues.

France Invest recommends an operational approach based on specificity, materiality, priorities, and a phased approach. The goal is to incorporate the issues that are truly relevant to decision-making and the monitoring of the investment.

How does the fund determine the right price?

A good company does not automatically make for a good investment. The outcome also depends on the price paid and the terms of the transaction.

Valuation generally involves a combination of several methods.

• The multiples of comparable companies and recent transactions provide a market benchmark.
• Discounted cash flow estimates the economic value of future earnings.
• Finally, the " LBO " model measures the impact of debt, growth, margins, and selling price on potential returns.

The fund develops several scenarios to test the robustness of its analysis. It can simulate slower growth, shrinking margins, rising borrowing costs, or a decline in the valuation multiple.

This analysis makes it possible to set a maximum price. This price does not correspond to the most optimistic valuation of the company, but rather to the level beyond which the expected return no longer sufficiently compensates for the risks.

In its report , *Private Equity’s Reality Check: The GP Outlook for 2026*, Bain & Company notes that sellers’ valuation expectations and red flags identified during due diligence were among the main obstacles to closing deals in 2025. This situation underscores the importance of consistent discipline, even when a fund has capital available for investment.

How is the transaction structured?

The structure defines how the acquisition will be financed and managed. In a LBO, the fund typically combines equity and debt, the level of which must remain consistent with the company’s ability to generate cash flow.

The shareholders' agreement governs the relationships between the fund, management, and the other shareholders. It sets forth voting rights, decisions requiring special approval, disclosure obligations, and the terms of sale.

The governance structure must enable the fund to support the company without taking over day-to-day management from its executives. The board of directors then serves as a forum for monitoring, strategic decision-making, and risk management.

The exit strategy is also considered from the outset. The company could be sold to an industry player, another fund, or taken public. This consideration does not mean that the exit date and price are known in advance. It simply ensures that there are several plausible paths to liquidity.

What is the role of the investment committee?

The investment committee is the body responsible for approving or rejecting the private equity deal. The team in charge of the deal presents the company, the investment thesis, the audit findings, the valuation, the financing, and the value creation plan to the committee.

Committee members test the assumptions against adverse scenarios. They seek to understand what events could jeopardize the project and whether the proposed safeguards are sufficient.

This structured contradiction helps limit confirmation bias. After several months of work, a team may be tempted to focus on information that supports the project. The committee must maintain the necessary distance to reexamine the case as a whole.

The decision may be positive, negative, or conditional. For example, the committee may require a price reduction, an additional audit, a change in financing, or the hiring of an executive before authorizing the investment.

Why are some deals abandoned?

Abandoning a transaction does not necessarily constitute a failure. It may indicate that the selection process correctly identified a risk that was not apparent at the outset of the discussions.

The fund may withdraw if growth depends on a small number of clients, if actual profitability is lower than reported, or if a legal risk arises. Management disarray, excessive debt, or an overly fragile IT system can also jeopardize the transaction.

Disagreement over price remains a common reason for withdrawal. If the seller refuses to account for the risks revealed by the audits, the fund may conclude that the potential return no longer justifies the investment.

Discipline, then, means walking away, even when time and fees have already been committed. Continuing solely to recoup the costs of the analysis would expose the fund to the sunk-cost fallacy.

What happens after the acquisition?

The closing does not mark the end of the analysis process. It marks the beginning of the phase in which we support the company.

due diligence 's findings are translated into operational priorities. The fund and its executives define the metrics used to track growth, profitability, cash flow, and the progress of strategic projects.

Initial actions may include strengthening the team, improving reporting, securing information systems, or preparing for an acquisition. The timeline for these actions depends on the specific needs of the investment.

Support must maintain a long-term perspective while laying the groundwork for an exit. In its Annual Report on the Global Private Equity Market dated February 23, 2026, Bain & Company estimated that in 2025, the average holding period for divested assets was around seven years. The firm also identified approximately 32,000 companies not yet sold in global portfolios, with an estimated value of $3,800 billion.

These data show that an acquisition cannot be analyzed in isolation from its future liquidity. A sound value creation plan must improve the company while enhancing its appeal to future acquirers.

What the selection of deals reveals about a Fund manager

For investors, the analysis of a fund should not be limited to a few high-profile holdings. It should focus on the consistency of all decisions made by the Fund manager.

First, it is important to examine whether the investments made actually align with the stated strategy. A fund that regularly changes its sectors, geographic focus, or the size of its investment targets may lack discipline or be trying to deploy its capital too quickly.

Next, we must understand the source of value creation. Growth resulting from increased revenue, improved margins, and organizational strengthening does not have the same significance as returns that depend primarily on debt or rising multiples.

Consistency is also more important than a one-time transaction. The analysis must cover multiple investments, multiple time periods, and different market phases. It must also take into account losses, delayed exits, and investments that are still valued but not yet realized.

Finally, the selection of companies must be viewed in the context of the selection of the Fund manager. Access to a high-quality deal flow is valuable only if it is accompanied by a repeatable methodology, industry expertise, and governance capable of rejecting deals that are not sufficiently attractive.

Conclusion

The selection of private equity deals is based on a structured process that begins with sourcing and continues through screening, due due diligence, valuation, structuring, and the investment committee.

A company’s intrinsic quality alone is not enough. The target must align with the fund’s strategy, be acquired at a reasonable price, and have a realistic value creation plan. The risks must also be understandable, trackable, and manageable throughout the holding period.

For the end investor, understanding this process makes it easier to evaluate a private equity firm. What truly sets a firm apart is not just the number of private equity deals it has access to, but its ability to select the right companies, support them, and structure their exits on terms that align with the interests of its investors.

Key Takeaways

In 2025, the global value of buyout investments reached $904 billion, even as the number of transactions declined. This concentration underscores the importance of disciplined selection.

A fund doesn't just choose a growing company. It looks for a target that aligns with its strategy, has a clear business model, a strong management team, and a credible plan for creating value.

due diligence s covers commercial, financial, legal, tax, operational, technological, and ESG aspects. It reduces uncertainty, but can never eliminate all risks.

Ultimately, the quality of a deal depends as much on the company as it does on the price paid. An attractive target can become a risky investment when its valuation is based on overly optimistic assumptions regarding growth, margins, or an exit.

FAQ

What is a private equity deal?

A private equity deal is a transaction in which a fund acquires an equity stake in a privately held company. This investment can finance the company’s growth, facilitate its succession, or support a strategic transformation.

How do investment funds find companies to invest in?

The funds identify their targets through investment banks, M&A advisors, their own networks, and direct outreach to executives. The total number of opportunities they are tracking constitutes their deal flow.

What are the main selection criteria?

The funds analyze the market, competitive positioning, business model, management team, financial strength, risks, and potential for value creation. These factors are then weighed against the asking price.

What Is a Private Equity " due diligence "?

due diligence refers to all the analyses conducted prior to an investment. Its purpose is to verify the information provided by the company and to identify risks that could affect its value or growth.

Who decides to make the investment?

The final decision generally rests with the investment committee. The committee reviews the investment thesis, valuation, financial structure, risks, and exit strategy before approving or rejecting the transaction.

Why might a fund walk away from a deal?

A fund may withdraw when results are weaker than expected, when a major risk arises, or when the price is no longer in line with the company’s outlook. Withdrawing in such cases can be a sign of discipline.

Does the " due diligence " eliminate all risks?

No. It provides a better understanding of known risks, but it cannot anticipate all economic, regulatory, technological, or competitive developments. Private equity investments involve, in particular, the risk of capital loss and illiquidity.