Private equity (PE) investments have expanded significantly across sectors such as industrials, education, logistics, and technology. As PE firms continue to optimize companies for profitable exits, strategic buyers must scrutinize deals more carefully. What looks financially healthy on paper may conceal operational vulnerabilities and sustainability risks.
For investment professionals evaluating these opportunities, this is not just about valuation, it’s about vigilance. The following framework brings together lessons from finance, operations, and governance to help strategic buyers protect value and drive long-term performance after a PE exit.
Why PE-Backed Deals Require Special Attention
PE-backed deals often look impressive on the surface. Many exit-ready businesses are structured with lean operations, aggressive working capital models, and optimized tax strategies designed to boost short-term returns. But what benefits the seller can complicate life for the acquirer.
Strategic buyers are not just acquiring a company, they are inheriting years of decisions optimized for exit, not permanence. Unlike financial buyers, they must think about long-term integration, capability building, and stakeholder alignment. That requires going beyond headline numbers to examine the operational DNA of the business: its systems, culture, and true earning power.
Key Risk Areas When Acquiring from Private Equity
To move from surface-level diligence to true insight, acquirers need to understand where short-term engineering can distort long-term value.
1. Adjusted EBITDA vs. Real Earnings
PE sellers often present inflated EBITDA through excessive add-backs, sometimes labelling recurring costs as “one-offs.” For example, a tech firm reported USD 15 million in adjusted EBITDA but excluded USD 4 million in platform support costs that would recur annually.
To separate sustainable earnings from presentation effects, finance teams should build a bottom-up model validated through department-level interviews and benchmark results against peer data. This recasts EBITDA to reflect true ongoing performance.
2. Deferred Capex and Investment Gaps
In the race to show high free cash flow, PE owners may delay critical investments in infrastructure, maintenance, or IT systems. The short-term optics can be impressive—but the long-term costs can be steep.
A logistics company that deferred fleet modernization, for example, faced sharply higher maintenance expenses post-acquisition. Analyzing historical capex-to-depreciation ratios and conducting technical due diligence on asset quality can help buyers uncover hidden reinvestment needs before they turn into surprises.
3. Sale-Leaseback Structures
Sale-leasebacks often release capital upfront but create future obligations. Buyers inherit long-term leases with inflation-linked escalators that can squeeze margins in downturns.
In one case, a retail chain was acquired with above-market lease rates, eroding profitability as consumer demand softened. Finance leaders should run lease sensitivity models and evaluate occupancy alternatives before finalizing valuation to ensure apparent liquidity doesn’t mask future constraints.
4. Working Capital Management Games
Working capital can be another area of distortion. PE-backed firms sometimes stretch payables or accelerate receivables to inflate cash conversion metrics before exit.
To identify manipulation, buyers should normalize net working capital over a rolling 12-month cycle and speak directly with key vendors to confirm true payment terms. Transparency here can reveal whether “efficiency” is real or engineered.
5. Management and Organizational Depth
Lean management structures make companies look efficient but can leave thin leadership benches. Middle managers who carry institutional knowledge may depart post-transaction, leaving critical capability gaps.
Strategic buyers should assess management continuity early and build retention and onboarding plans into the integration phase. Sustaining performance requires leadership depth, not just financial efficiency.
6. Non-Recurring Commercial Gains
Short-term pricing actions, temporary promotional pushes, or early revenue recognition can inflate top-line growth right before an exit.
Analyzing revenue at the contract level helps distinguish one-time effects from ongoing trends. This analysis supports more realistic revenue forecasts and helps determine how much growth is repeatable versus engineered.
7. Tax, Legal, and Compliance Overhangs
Finally, optimized holding structures may conceal contingent liabilities or unresolved regulatory risks. Complex entity charts, related-party arrangements, or untested tax positions can pose hidden exposure.
Finance diligence teams should deploy integrated legal-tax reviews to identify transfer pricing risks, structure unwind costs, or potential disputes that may resurface after closing.
Valuation Challenges in PE Exits
Valuation in PE-backed exits often becomes a negotiation between deal optics and underlying fundamentals. Multiples may appear consistent with peers but often rest on inflated earnings or deferred investments.
Strategic buyers should approach valuation through a forensic lens that links financial performance to sustainability. Here are some techniques:
- Recasted EBITDA: Adjust for normalized personnel costs, recurring vendor contracts, and hidden support functions previously absorbed by the PE sponsor.
- Cash Conversion Reality: Review multi-year cash flow data to identify distortions from one-off working capital plays or timing adjustments.
- Capex Benchmarking: Compare historic and forecasted capex-to-sales or capex-to-depreciation ratios against industry norms to model true reinvestment needs.
- Integration Adjustments: Layer in post-deal costs such as system integration, shared service migrations, or rebranding, which are often omitted from PE forecasts.
- Exit Multiple Sensitivities: Build conservative scenarios reflecting slower growth and margin normalization to stress-test returns.
A robust valuation process triangulates several methods: adjusted EV/EBITDA on normalized earnings, discounted cash flow models with integration overlays, and public comparable ranges discounted for private market opacity and liquidity risk.
Valuation should capture not only what the company has been but how resilient and future-ready it is likely to be under strategic ownership.
Financial Lessons and Diligence Enhancements
Across transactions, one pattern is clear: thorough diligence and financial scrutiny often determine post-acquisition success. The most effective acquirers don’t stop at validating earnings; they test the durability of the business model, culture, and governance.
Commissioning quality-of-earnings reports that integrate operational realities, rather than focusing only on accounting reclassifications, helps uncover recurring costs hiding in temporary classifications. Scenario planning tools can then stress-test lease obligations, debt refinancings, and other contingent risks.
Strategic buyers should also ensure that post-acquisition reporting structures, governance processes, and system integrations are mapped before the deal closes. Scrutinizing the board composition and oversight culture inherited from PE owners is equally vital. Recasting valuation models with a bottom-up lens — rather than relying solely on PE-crafted projections — adds transparency and reduces surprises.
These practices shorten the time to value realization and strengthen confidence across stakeholders, from management teams to lenders.
Why This Matters for Investors and Stakeholders
For institutional investors, lenders, and corporate acquirers, the cost of overlooking these risks is high. Governance lapses, misaligned incentives, or deferred investment can erode equity value and trigger covenant breaches. Conversely, transparent diligence and post-close financial leadership can stabilize performance and rebuild confidence.
In today’s competitive deal market, understanding the true financial and operational underpinnings of PE-backed assets is not optional, it is essential. The line between financial engineering and sustainable value creation is thin, and strategic buyers must be prepared to tell the difference.
References
https://assets.kpmg.com/content/dam/kpmg/ie/pdf/2024/02/ie-healthcare-horizons-cge-health-2.pdf
https://www.pwc.com/us/en/services/consulting/deals/library.html
