Financial Poise
pushpins on a map, symbolizing investment strategy

5 Investment Strategies PE Firms Use to Choose Portfolio Companies

How Investment Strategy is Decided

As a threshold matter, keep in mind that private equity funds, by definition, invest in established companies with real revenue. Portfolio companies are often more mature companies, unlike venture capital portfolio companies, and represent a less risky investment strategy. While many experts categorize venture capital as a subset of private equity, some do not.

A PE firm’s investment strategy starts with its investment mandate. An investment “mandate” is revealed in the marketing materials and/or legal disclosures that you, as an investor, need to review before ever investing in a fund. Stated simply, many firms pledge to limit their investments in particular ways.

A fund’s strategy, in turn, is usually (and should be) a function of the expertise of the fund’s managers.

5 Ways to Focus Investment Strategy

How, when, and in what fashion a PE firm chooses its portfolio companies can be categorized in several ways.

There are secondary factors that influence how private equity firms choose portfolio companies. PE firms are comprised of members with different areas of expertise. The expertise of a particular PE firm facilitates the selection of portfolio companies. Some determining factors are:

1. Lifecycle

Growth capital invests in slightly more mature companies that are growing and profitable; however, these companies have financial limitations. Such limitations inhibit further development and expansion. To generate capital, such companies sell equity but maintain majority ownership. Case studies concerning growth capital can be found at Private Equity Growth Capital Council’s website.

Leveraged buyouts (LBOs) concentrate on the acquisition of mature, stable companies. The transaction is financed by two sources: equity (selling the ownership of the company) and debt (borrowing money to use as leverage). A “management buyout,” is a type of LBO in which the main buyer is the current management team, supported by a PE firm. Perhaps the best known LBO was that of RJR Nabisco by KKR in 1988. Bryan Burrough and John Helyar wrote about this in Barbarians at the Gate: The Fall of RJR Nabisco.

Distressed investments and special situations pertain to investments in equity or debt securities of companies that are experiencing financial distress.

2. The Size of the Company

Firms look at the size of a company based on EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), revenue and total assets. You may find that a firm focuses on middle-market companies if they prefer to take a more active role in management.

3. Geography

A firm may limit portfolio companies to one region, or they may choose companies in multiple regions for greater diversification. Sometimes equity funds like to be close to the companies in which they provide input, which can make the company easier to advise and manage.

4. Industry

Investment firms may choose portfolio companies based on a particular industry, especially if they can provide the expertise that the portfolio company needs in order to grow. For example, a firm may focus specifically on industrial machinery or healthcare companies. A manager will also research industry trends and the growth potential within certain industries.

5. Investment Size

PE funds want to know how much capital needs to be invested into a portfolio company in order to improve value and make a profitable return.

All these factors influence how a PE firm narrows down the pool of potential portfolio companies. Once the company has been selected, private equity firms begin negotiations and conduct due diligence. Finally, the PE firm decides whether or not to invest in a particular company.


Diversification is an important part of an investment strategy, because it mitigates risk by assuming that not all investments will be a success. It’s why, as an investor, you don’t put all of your capital into just stocks or just private equity.

Josh Lerner, author of Venture Capital, Private Equity, and the Financing of Entrepreneurship, writes , “… different GPs treat diversification differently. For instance, Warburg Pincus, a top-tier private equity firm, raises a single fund and invests across a host of stages, geographies, and industries. Sequoia Capital [in contrast] initially raised a number of different funds, some for U.S. early stage, others for India, another for China.”

Successful portfolio management requires a balance between investment strategy and diversification policy; however, there is no standard approach concerning the selection of investment strategy and diversification policy. It is the choice of the PE firm.

As a result, when investing in a PE fund an investor must conduct her own due diligence to gather all the crucial information to make an informed investment decision. Information about individual PE firms’ investment strategies, and their diversification policy, can be usually found on their websites.

Even though in most cases the information is vague, what is offered can provide a partial view of a particular firm’s investment strategies. The details of an investment strategy are described in greater detail in a fund’s Limited Partnership Agreement, often in a section commonly titled “Investment Policy Guidelines.”

[Editor’s Note: To learn more about investment strategy and related topics, you may want to attend the following webinars: Opportunity Amidst Crisis- Buying Distressed Assets, Claims, and Securities for Fun & Profit and Advanced Investing Topics: Unicorns and Pre-Unicorn Scalable Private Company Propositions. This is an updated version of an article originally published on January 8, 2014.]

About Kaja Kwasniewska

Kaja launched Linque in 2014 as an answer to a need that she identified. Since that time, her mission is to help international companies to successfully tap into the US market. Prior, she was Director of Strategic Growth at Chicago-based start–up DailyDac and spent 5 years in KPMG as a management consultant.

Read Full Bio »   •   View all articles by Kaja Kwasniewska »

Article Comments