Screening & Initial Assessment
How PE firms quickly filter hundreds of opportunities down to a short list
~15 min read
A PE firm that reviews 800 deals per year cannot perform deep analysis on every one. The screening process is designed to quickly eliminate opportunities that do not fit the fund's mandate and focus diligence resources on the highest-potential targets. Good screening is ruthlessly efficient: most deals should be killed within 30 minutes of the first review.
Screening is the first filter in what becomes a progressively narrower funnel. The goal is not to find reasons to invest but rather to find reasons not to invest. Every hour spent on a deal that will never close is an hour not spent on one that could generate returns.
Investment Criteria: The Fund's Buying Parameters
Every PE fund has a defined set of investment criteria that guide its screening process. These criteria are established during fundraising and communicated to LPs in the fund's Private Placement Memorandum (PPM). Deviating significantly from stated criteria can create legal and reputational issues with LPs. Core criteria typically include:
- Size: Enterprise value or EBITDA range (e.g., $10M-$50M EBITDA for a mid-market fund).
- Sector: Target industries or explicit exclusions (e.g., 'business services and healthcare, no oil & gas').
- Geography: Domestic vs. international, or specific regions.
- Growth profile: Minimum revenue growth rate or evidence of secular tailwinds.
- Margin profile: Minimum EBITDA margins (e.g., 15%+ for service businesses, 20%+ for software).
- Deal type: Platform acquisitions, add-ons, carve-outs, take-privates, or some combination.
A deal that falls outside these parameters is an automatic pass, regardless of how attractive it might otherwise be.
Common Deal Killers: Red Flags in the First 30 Minutes
Experienced investors develop pattern recognition for issues that make a deal unattractive regardless of other merits. These 'deal killers' allow rapid screening decisions:
- Customer concentration: If one customer accounts for more than 20-30% of revenue, the business is too dependent on a single relationship. Losing that customer could be catastrophic.
- Cyclicality: Businesses with revenue that swings dramatically with economic cycles (e.g., construction, commodity-linked) are harder to leverage and harder to predict.
- Regulatory risk: Industries facing potential regulatory disruption (e.g., pending legislation that could eliminate a revenue stream) carry risk that is difficult to underwrite.
- Owner dependence: If the founder is the business and all key relationships, IP, or expertise leave when the founder leaves, the acquisition may not retain its value.
- Declining revenue: Unless there is a clear, credible turnaround thesis, shrinking businesses are avoided by most buyout funds.
- Unrealistic seller expectations: If the seller's price expectations are 30-50% above what the firm's analysis supports, the gap is usually too wide to bridge.
- Litigation overhang: Pending lawsuits with material exposure can create unquantifiable risk.
The Teaser and NDA Process
The formal screening process for auction deals follows a predictable sequence:
- Receive the teaser. The investment bank or intermediary sends a one-to-two page document that describes the target company in general terms. A good teaser includes approximate revenue and EBITDA, the industry, the geographic region, a brief description of the business model, and the reason for the sale. The company's name is not disclosed.
- Initial screen against criteria. A junior team member (analyst or associate) compares the teaser against the fund's investment criteria. Does it fit by size? Sector? Geography? If not, it is passed immediately.
- Sign the NDA. If the opportunity passes the initial screen, the firm signs a non-disclosure agreement with the seller, which grants access to the company's identity and the Confidential Information Memorandum.
- Review the CIM. The team reads the CIM and performs a deeper assessment of the business, its financials, its market, and its growth prospects. This review typically takes 1-2 days.
- Internal screening meeting. The deal team presents a brief summary (often a 3-5 page memo or a 10-slide deck) to the firm's investment committee or a senior partner. The committee decides whether to proceed with an IOI or pass.
The entire process from teaser to screening decision typically takes 1-2 weeks for auction deals.
| Criterion | Pass | Fail (Deal Killer) | |
|---|---|---|---|
| Size (EBITDA) | Within fund's target range | Too small or too large for the fund | |
| Sector | Core or adjacent to fund's expertise | Outside stated mandate or LP restrictions | |
| Customer concentration | No customer > 15-20% of revenue | Top customer > 30% of revenue | |
| Revenue trend | Stable or growing | Declining with no credible turnaround plan | |
| EBITDA margins | At or above industry average | Well below peers, no clear fix | |
| Seller price expectation | Within range of comparable transactions | 30%+ above supportable valuation | |
| Owner dependence | Professional management team in place | All value tied to departing founder |
A 30-Minute Screen: HVAC Services Company
A sell-side advisor sends a teaser for an HVAC services company in Texas. The teaser shows $8M EBITDA, 20% margins, 10% annual revenue growth, and a fragmented competitive landscape. The analyst at a mid-market PE fund ($500M fund targeting $5M-$25M EBITDA) runs through the quick screen:
- Size: $8M EBITDA is within the fund's $5M-$25M range. Pass.
- Sector: HVAC services is a core focus area. Pass.
- Geography: Texas, domestic. Pass.
- Growth: 10% annual growth with secular tailwinds (aging infrastructure, climate trends). Pass.
- Customer concentration: The teaser mentions 'diversified customer base with no customer > 5% of revenue.' Pass.
- Reason for sale: Founder retirement after 25 years. Common in lower middle market. Neutral to positive.
The analyst signs the NDA, requests the CIM, and begins a deeper review. Within 48 hours, the deal team will decide whether to present the opportunity at the next screening meeting and potentially submit an IOI.
Initial Financial Analysis: What to Look at First
When a deal passes the quick screen and the team receives the CIM, the initial financial analysis focuses on a few critical areas:
- Revenue quality: Is revenue recurring, contractual, or project-based? Recurring revenue (e.g., maintenance contracts, subscriptions) is valued more highly because it is more predictable.
- EBITDA bridge: Reconcile reported EBITDA to adjusted EBITDA. Look at add-backs (owner compensation above market, one-time expenses, non-recurring items) and assess whether they are legitimate.
- Working capital: Does the business require significant working capital to grow? High working capital intensity reduces free cash flow available for debt service.
- CapEx requirements: Differentiate maintenance CapEx (required to keep the business running) from growth CapEx (investment in expansion). High maintenance CapEx reduces distributable cash flow.
- Implied valuation: Back into an implied entry multiple based on likely transaction values for comparable businesses. If the implied multiple exceeds the fund's return threshold, the economics may not work.
Quiz: Screening & Initial Assessment
5 questions · ~3 min