How to tell a winning deal from a losing one, before you sign

Private equity returns are made by a minority of deals. In the published record, about one buyout in four returns more than 50 per cent a year, and about one in four loses money. Looking back, the winners tend to share a small set of features that were visible at entry. The losers share another.

Neither list is a guarantee. Both show where to look.

Here are two lists of six. They are general on purpose. No threshold turns a business into a winner. The question is whether each sign is there, and whether anyone has proved it.

Six signs of a winner

1. The segment grows for a reason you can name. Look at the part of the market the business sells into. The growth has a cause that will still be there in five years. An ageing population, a rule that forces adoption, a product customers are switching to.

2. The business is taking share on its own. Like for like, without acquisitions doing the work. Customers can say why they chose it. Their reason differs from what they say about its rivals.

3. The expansion muscle already exists. The business has opened a new region, launched a product or entered a channel before. The result is in its revenue today.

It knows how to do it again. A runway that has been walked on, not one drawn on a slide.

4. There are businesses to buy at sensible prices. And a business that can absorb them. A list of targets proves little. The test is whether the last one was integrated.

5. Margins rise for a reason. Each point of improvement has a lever, and each lever has a mechanism. A forecast that drifts upward has neither.

6. You can name who buys it from you. And you have a good answer to the awkward question: why are they not buying it now?

Three public deals show the signs at work.

Healthscope, 2010. Two buyout firms bought Australia's second-largest private hospital operator. Demand was growing for reasons anyone could name: hospital admissions and private health insurance membership were both rising.

The expansion muscle was proven. The business had been adding beds to its existing hospitals for years. Under its new owners it ran twenty-one more of those expansions.

Margins rose from about 14 per cent to over 15, with the levers visible. More beds went on sites already owned. A weak pathology division was restructured and partly sold.

The way out was the public market. Four years later the company re-listed at the top of its price range.

Hilton, 2007. International travel was growing. The buyer's case rested on a different model: grow the brand through franchised and managed hotels, which other people pay to build. The company already knew how to do that, and did much more of it. Rooms and fee income grew while capital needs fell.

The deal was badly timed, bought months before a financial crisis. Its value was written down heavily along the way. It survived because the debt could be restructured.

Reports widely describe it as the most profitable buyout on record. A winner can look like a loser for several years.

Dollar General, 2007. A discount retailer bought just before a recession. Its customers needed it more when times were hard, so the segment grew for a reason that got stronger.

It had a long record of opening stores and kept opening them. The new management closed the unprofitable ones, and profits rose sharply. It re-listed within about two years.

Six signs of a loser

1. The competition is changing shape. A low-cost entrant. A shift online. A channel that is starting to go around the business.

The numbers still look fine, because last year always does.

2. A technology or a rule could take the market, and the case waves it away. The risk is listed at the back of the report, judged unlikely, and never priced.

3. The growth market is nearer its peak than the plan assumes. Adoption curves flatten. A market that doubled in five years rarely does it again.

4. The case only works if every acquisition lands. A buy-and-build plan with no room for one bad deal, one late integration or one seller who will not sell.

5. A cyclical business, bought late in the cycle. With no recession case in the model, or a recession case in which nothing serious happens.

6. Margins that improve in the forecast with nothing behind them. The same line as the winner's fifth sign, without the mechanism.

Three public deals show these signs too.

Dick Smith, 2012. The consumer-electronics chain was bought from its listed parent. The seller had called it non-core. It said its investment in the brand was out of proportion to the profit.

The category was moving online and its prices were falling. The business was floated thirteen months later. Two years after that it was in receivership. The first sign was in the seller's own announcement.

Healthscope, 2019. The same hospital group was bought a second time, by a different buyer. It paid a much higher multiple of earnings, after a year-long contest.

By then the growth that carried the first deal had slowed. The price assumed it had not. In 2025 receivers were appointed.

Same company, same sector, opposite signs. We set the two deals side by side in a separate piece.

A large wine producer, 2018. Bought on the promise of growth in one Asian market. Access to that market depended on one government's goodwill.

When that changed, the growth went with it. The lenders ended up owning the business. The risk had been listed and dismissed.

How to use the lists

A winner sign counts only if it is evidenced. Structural growth from a source you did not have to take on trust. Share gains in the numbers. An exit buyer you have spoken to. A sign that is only asserted goes in the diligence plan and stays out of the base case.

A loser sign counts even when it is only possible. It goes into the downside case, with the event named, the early warning named, and the price checked against it. If the deal cannot survive one of them, that is worth knowing before the auction.

The research on buyers helps here too. Across more than a thousand buyouts, the price paid followed the cost of borrowing more closely than the quality of the asset. When credit is cheap, every deal looks like a winner. Then the second list earns its keep.

Our fund check asks these questions and scores the evidence behind each answer. It stops short of saying whether to do the deal.

It gives one of four readings of the case. Keep going. Slow down and finish the homework. Slow down, there are real doubts. Or stop.

Ten minutes, before the committee meets.

• The deal checks: buying as a fund, buying as a strategic acquirer, and selling
• How a Stages of Excellence check works
• Half of buyouts miss the plan they were bought on