Investment decisions weigh heavily: they tie up capital but are almost impossible to revise in the short to medium term. They set the course for the future, but are based on the here and now. So how can you decide whether the marginal return on capital will be higher than the market interest rate? In the case of company investments, the answer is: above all with a plausibility check of the business plans submitted by the target company.
Investors will therefore want to clarify whether
- the assumptions about the company's future development hold up,
- the company's goals are realistic and
- the strategies are to be implemented.
It's all about the right mix
In the plausibility check, it is important to examine the business plan from several angles, as this is the only way to bring the profile of the corporate strategy into sharp focus. The target company's direct and indirect competitors, the structure of the market in which it operates and the current trends in the industry are certainly important aspects. In any case, a plausibility check is characterized by a mix of different qualitative and quantitative methods.
In my experience, you should proceed as follows:
1. Start the plausibility check very early.
In my opinion, the plausibility check of business plans submitted by a target company should start at a very early stage of the decision-making process. The reason for this is that reviewing the content of business plans is a deeply iterative process: New findings are incorporated into the assessment, which must be revised, adjusted and improved time and again.
But such a process must be able to start from somewhere. The assumptions and calculations on which the business plans are based must therefore be checked from the outset - even if the findings that would make a reliable assessment possible are not yet available in detail.
2. Formulate clear criteria.
For the plausibility check, you need criteria that are meaningful. They will have to be different depending on the target company and economic situation. They must therefore be reformulated from case to case. The formulation of criteria typically starts with questions such as the following:
- What is the company's situation? What level of maturity does it have? What is its market position?
- How should the company's USPs be assessed?
- What are the growth drivers or inhibitors?
- What is the company's image?
- How is the company's position compared to its competitors?
- How are the market and competition structured within the industry? (concentration vs. diversification)
- Which relevant megatrends need to be considered? Is there a threat of decline or substitution by a substitute product? Will new opportunities arise? And if so, where?
- What specific risks are there and how should they be assessed?
The criteria resulting from the answers to these and other questions can be further developed into criteria for a quantitative analysis of business plans or variables of a planning model in a second step.
3. Get market and industry knowledge in-house.
When developing your business plans, the management makes certain assumptions that result - explicitly or tacitly - from the assessment of your market position. If you want to check the plausibility of these assumptions in a precise and well-founded discussion with the company management, you will have to carry out a precise market analysis.
This requires founded market and industry knowledge, which is not always available in-house. In this case, it is worth working with an external expert in the relevant market, whose expertise can be called upon quickly and purposefully for the analysis.
4. Analyze the competition.
Only in very exceptional cases will a company not be in competition with others offering a comparable product. A thorough competitive analysis is therefore an important step in the plausibility check. Putting the target company's business plans in relation to its most important competitors provides answers to questions such as the following:
- Does the company have the pricing power to significantly increase prices?
- Is there a "moat" that hinders or prevents potential competitors from entering the market?
A positive answer to such questions suggests a return on investment and is a strong indication that an investment would be worthwhile.
5. Consider projections.
Entrepreneurial action focuses on the future. The projection of existing results is therefore an essential criterion for determining whether business plans are plausible or not. The broader the informational basis of such a projection, the better. Information from the dataroom and company presentations, as well as information from interviews with stakeholders inside and outside the company, is essential.
In light of this projection, the future sales strategy of the target company can be critically examined. An examination with regard to the development of costs, prices and market shares, the prospects of success of new products and the results of the customer analysis is particularly revealing.
Investment risks will become particularly apparent here.
6. Continuously compare partial results with the figures.
Reviewing a business plan is a step-by-step process. Also, because interim results are achieved using very different methods, they are hypothetical by nature and that means: provisional. If new findings are obtained, individual results may appear in a new light and need to be reinterpreted, possibly even revised. You should therefore repeatedly compare the results achieved with the figures or due diligence throughout the entire project and adjust the planning model if necessary.
This is the only way to ensure that your assessment is based on hard figures.
Conclusion: Private equity investments are not a game of chance
Whether a private equity investment plan makes sense depends very much on the plausibility of the business plans presented by the target company. Plans and strategies should therefore never be simply accepted. On the contrary: before investing, I would always analyze the corporate strategy and the assumptions on which it is based in detail and examine it from several angles.
In concrete terms, this means:
- apply several methods.
- Validate partial results by comparing them with the figures.
- Adjust already achieved results in the light of new findings if necessary.
Would you like to invest in a company? Let's arrange a meeting and discuss the next steps towards a reliable assessment of your target company.
