How to Write an Investment Thesis in Private Equity

Private Equity
Last updated:
January 10, 2023

2022 was tough for M&A. Private equity deal volume was 46% lower than the previous year. Venture capital deals were down 42% globally in the first 11 months. And as deal volume slows, dry powder continues to grow, with more than $1 trillion USD in the US alone.

This surplus of cash coupled with a lack of deal flow means firms must change how they do business to succeed in 2023. While the first step is to supplement intermediary deals with a direct sourcing model, economic uncertainty is causing firms to refine their outbound strategies. 

Dealmakers must find ways to be highly efficient with their time and search only for the most strategic investments. They must make a strong case for each and every transaction with a clear rationale of why this company should choose their firm amidst stiff competition. 

The best way to do that is by carefully crafting an investment thesis and using it to guide your direct deal sourcing efforts. Keep reading to learn more.

What Is an Investment Thesis in Private Equity?

An investment thesis is, quite literally, a thesis statement. It’s succinct, yet comprehensive enough to serve as your firm's guiding principle to both source and secure ideal investments. 

Imagine you're back in school and writing a term paper. Remember how a thesis was treated as a single defining statement that guided the development of your entire paper? The same is true of an investment thesis for your private equity firm. Unlike your term paper, however, firms often have more than one thesis because they often focus on multiple types of deals at once. 

Dealmakers’ theses can also be broken down into two specific types: top-down and bottom-up. A top-down investment thesis is something that helps your team understand and seek out ideal investment targets when sourcing.

Top-Down Investment Thesis for Venture Capital Example: "This $10MM seed fund focuses on US-based cannabis startups that are furthering the industry through technology and infrastructure research and development that can leverage our partners' vast experience in the logistics and supply chain sectors.”

Once your firm has identified an ideal company that fits its top-down thesis, it’s time to create a bottom-up version. Far more direct and specific in nature, a bottom-up investment thesis includes everything from particular information about the target company — including financial statements and forecasting, future business plans, funding strategy reasoning, industry trends, etc. — as well as why your firm is the best choice.

Bottom-Up Investment Thesis for Private Equity Example: "Smith Partners is seeking to invest a $20MM Series A round in Asclepius, Inc. to aid in their rapid growth and contributions to the advancement of the healthcare industry. Their dedication to modernization combined with SP's vast network of cutting-edge automation manufacturers and forward-thinking healthcare providers make this partnership particularly exciting."

A bottom-up thesis would then continue into specifics about the company, detailing financial and employee records, proprietary knowledge or advantages such as patents, and more about what your firm brings to the transaction. A final bottom-up thesis can take many different forms: e.g., a comprehensive document, presentation, or video.

The key to both a top-down and bottom-up investment thesis is specificity. Every thesis your firm creates should be valid only for your firm. The combination of geographic location, sector or industry, company stage or type, fund size, reasons behind the investment or focus, and your firm's specific differentiators should make each of your theses unique.

Steps for Building an Investment Thesis Framework

Creating an investment thesis framework will help your firm draft theses more quickly and make sure all of the necessary information is included. Answering the following series of questions is a good place to start building a framework for both top-down and bottom-up theses:

  1. What is the goal of this thesis? This answer takes one of two forms: to find new target investment opportunities or to secure a potential deal. But before you can detail the rest of the thesis, you must know your end goal.
  2. What are the basic parameters of your ideal deal? Once you have your overall goal, sort out the basics first: overall available capital, company demographics (e.g., location, size, industry), etc.
  3. What are the influencing internal factors? What is your firm hoping to get from a deal that would fit this thesis? Do you need to bridge a valuation gap in your portfolio, for example?
  4. What are the influencing external factors? If you've ever gone through a thematic sourcing exercise, this will feel similar. While your thesis should not be nearly as large in scope as a thematic investing strategy, socioeconomic or industry trends can be a driving factor for why your firm is looking at this type of investment and should be called out in your thesis.
  5. Why your firm? While this is the simplest question, it's not only the most difficult to answer but also the most important. Your differentiator — what only your firm can offer to the industry or target company — and why you are particularly suited to this segment of the market (in a top-down thesis) or specific deal (in a bottom-up thesis) is the key to crafting a successful investment thesis in private equity.
  6. Why this deal? For a bottom-up thesis, you must detail why this deal should be transacted:
  • Why this company? Is it the founder that instills confidence? Do they have intellectual property that makes the deal worthwhile? How are their financials impacting this decision?
  • Why now?
  • What does the future look like and what are your plans post-transaction?
  • What is the eventual exit strategy? When would you plan for that to happen?
  • How does this deal impact your portfolio?

The framework you build from answering these questions can then be refined into a single statement or document that serves as your thesis. But be prepared to make iterations. You must continually refine your theses as you gather more data, learn more about your ideal investment, and the world continues to evolve and change.

Putting Your Investment Thesis to Work

Once your firm creates a thesis, it's time to put it to work. Remember that at its most basic level, a thesis aids your team in qualifying opportunities to see if they're worth pursuing. 

Inputting the ideal criteria from your top-down thesis into a deal sourcing platform helps you map and understand the wider market, determine the most relevant conferences to attend, directly source the right opportunities, and much more. These tools can also help you learn more about specific target companies, their competitors, their investment readiness, and other key details to craft bottom-up thesis statements.

With over 130,000 sources and millions of data points, SourceScrub’s deal sourcing platform has helped firms improve their research productivity by 42.8% and deal sourcing pipeline by 36%. Let’s chat to find out how we can help you create and execute your investment theses in 2023 and beyond!

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