Private Equity Scorecard Approach: Quality versus Myth

Abstract

The author explains the practical approach of private equity funds in terms of target valuation wanders between unfathomable financial models and pure mythologizing. To solve that dilemma, the author developed and tested a new valuation model: the Private Equity Scorecard Approach (PESA™). The idea stems from analyzing, on the one hand, how the latest research shows that the average holding period of private equity funds is around six years (the consequence is a blur between the boundaries of financial and strategic investors). On the other hand, valuation of potential targets is based unilaterally on assessment of financial models, while there is no adequate explanation why a given multiple is used. Instead, in the proposed working model the multiple is a variable that evaluates the quality of the investee through quantifying, with a sound mathematical equation, the finance, clients, internal business processes, and knowledge perspective of the company. The results are benchmarked versus the industry leaders. In the case of PE funds, the quantity is given numerically—the company’s EBITDA. This approach has a straightforward logic behind it: The price of each commodity (for a PE fund, this is the company being acquired) is determined by its quantity and quality.

TOPICS: Private equity, fundamental equity analysis, performance measurement, portfolio construction