Chapter 5: The 7 Steps of a Private Equity Deal
You want to buy a company. Or at least a piece of one. How does that actually work? Chapter 5 of Demaria’s book lays it out in 7 steps. The whole thing takes 3 to 18 months depending on the deal. And really, the entire process boils down to one word: trust. Buyer and seller have to trust each other enough to make a deal happen. Let’s walk through it.
Step 1: Preliminary Analysis (Finding the Deal)
Before anything else, you need to find a company worth buying. This is called deal sourcing and it is basically networking. Fund managers build relationships over years with entrepreneurs, lawyers, accountants, and other investors. When a good opportunity comes up, someone in that network picks up the phone.
For LBOs, there are also formal auctions. A seller hires an investment bank to run a competitive process. Potential buyers sign a non-disclosure agreement and get a pre-packaged set of information. For venture capital and growth deals, it works differently. The startup’s management team is the one running the show, picking which investors they want to work with based on what they bring to the table beyond just money.
Most opportunities get rejected at this stage. The investment team writes up a quick memo to decide if it is worth going deeper. The filtering is strict on purpose. Every deal that goes past this point but does not close costs money. Those “aborted deal costs” eat into the fund’s returns. So the team wants to kill bad deals early.
Step 2: Initial Valuation
Now the team tries to figure out what the company is actually worth. Demaria describes three main approaches.
Comparable multiples. You look at similar public companies and recent transactions in the same sector. You take some financial metric like EBITDA and multiply it by the going rate. This is the most common method in PE. Aswath Damodaran’s work is the go-to reference here.
Discounted cash flows (DCF). You project the company’s future cash flows and discount them back to today. Sounds scientific, but you have to pick a discount rate and a growth rate, and those choices leave a lot of room for creative interpretation. Good for modeling different scenarios though.
Asset replacement cost. You look at the balance sheet and figure out what it would cost to rebuild everything from scratch. This is useful for finding hidden value, like real estate that is fully written off on the books but still worth a lot, or machines that need expensive replacement.
For startups, things get tricky. There is no real operating history. Investors usually look at a potential exit in 5 to 7 years, estimate what the company could be worth then, and discount backwards. If it is a really early stage company, they sometimes just assign an arbitrary valuation that gives them a 30%+ stake and focus on getting strong governance rights instead.
Bankrupt companies are their own puzzle. The accumulated losses act as a tax shield for future profits. But you need to add up restructuring costs, capital needs, and recovery time.
Once both sides have a rough idea of the price range, they sign a letter of intent (for LBOs) or a term sheet (for VC). This is not binding. It just says “we agree enough to keep talking.”
Step 3: Due Diligence and Negotiation
This is the big one. The most time-consuming and most important step. Once the buyer gets exclusivity, they go through everything. Financial records, legal documents, operations, contracts, management capabilities. Everything.
The goal is to narrow that valuation bracket down to a single number. As the due diligence uncovers things, good or bad, the price moves. The management team plays a key role here, especially when they are not the ones selling. They need to keep the company running while also helping both sides reach an agreement.
A few important details come up during this phase. Shareholders’ agreements get drafted. These include things like right of first refusal (if one investor wants to sell, others get first dibs), liquidity rules, and priority returns. For LBOs, the debt structure gets negotiated with banks too.
If the company’s future is uncertain, the deal might include earn-out clauses, where part of the price depends on hitting certain targets after the deal closes. There can also be warranties and representations, where the seller covers specific risks from the past.
Demaria makes a sharp point here: smart buyers do not just check the current state of the company. They start designing the value creation plan during due diligence. They build a “first 100 days” action plan before the deal even closes. Why? Because IRR is time-sensitive. Every month of delay in execution pushes the exit further out and kills returns.
Step 4: Structuring
Now you figure out the legal and financial architecture of the deal. Even a “simple” venture capital minority stake involves formal legal documents, stock option plans for employees, and a detailed shareholders’ agreement.
Common clauses include tag-along and drag-along rights (so investors can exit together), veto rights on major decisions like C-level hiring or big spending, and exit clauses with specific timeframes.
Stock options are a big tool here. If the management team has a small stake, giving them options aligns their interests with the investors. They benefit from the company’s sale, so they work harder to make it happen. On the flip side, if management fails to hit targets, there can be reverse mechanisms where founders get diluted.
For LBOs, the debt covenants matter a lot. They set financial targets (EBITDA levels, debt ratios) and non-financial ones (client acquisition rates, for example). Missing these can trigger renegotiation with the banks.
The best fund managers have already identified potential buyers for the company at this stage. They structure the deal with the exit in mind from day one.
Step 5: Complementary Due Diligence
Think of this as the final exam. Before closing, there are still audits to complete. Financial audits, environmental checks, tax reviews, social assessments. For companies with international subsidiaries or large inventories, this takes real time.
For VC deals, the audits might focus on technology, patents, or regulation. Demaria notes something important here: do not overvalue patents in isolation. A patent by itself is not worth much. It is valuable only as part of a stream of future cash flows. Investors will bring in IP lawyers and industry experts to verify the claims.
Step 6: The Transaction
The deal closes. Legal documents are signed. Money changes hands. Simple, right?
Not always. Deals can fall apart at the last minute. A material event happens. The banks back out because the auction pushed the price too high (“broken auction”). The structuring becomes impossible at the final price. An aborted transaction is expensive. All that due diligence money is gone.
For very large buyouts, multiple fund managers form consortia. Three or four groups of PE funds team up, share costs, and bring different expertise. In venture capital, the approach is different. Existing investors invite new ones to join, creating a “cluster” where each brings something specific, whether it is commercial networks, international expansion help, or IPO experience.
Step 7: Monitoring and Exit
You bought the company. Now what? The exit determines the actual return. Buying at a good price is only half the job. Managing the company well and selling at the right time is the other half.
The most common exit is a trade sale (selling to a strategic buyer). Second is selling to another fund. IPOs are the smallest category. Timing is difficult. You are trying to predict market cycles, industry trends, and valuation levels. Some funds have hired dedicated specialists just for managing exits and running M&A processes.
Demaria points to how large firms like Blackstone have evolved into full-service asset management houses. They advise, they invest, they lend, they list companies. Goldman Sachs makes most of its money from hedge funds and PE. These two can be partners on one deal, client and provider on another, and competitors on a third. The intricacy of these relationships raises questions about ethics and conflicts of interest, which Demaria promises to cover in Chapter 6.
What Makes a Deal Succeed
Demaria closes with a useful checklist. Successful PE investments share these traits: the company has real growth potential or strong barriers to entry, the valuation is reasonable, the management can handle professional investors breathing down their necks, there is a clear and achievable plan, and there is a realistic exit path.
But the real resource, he argues, is people. Entrepreneurs specifically. And here is a sobering data point: young people in the US are starting fewer companies than they did two decades ago. The myth of the young college dropout founder? The data says the most active voluntary entrepreneurs are actually older, more educated, and often Asian. Immigration drives a lot of entrepreneurship. And many “entrepreneurs” are really just self-employed people with no other option.
Capital is not the bottleneck. People willing to take smart risks are. That is the real constraint on private equity’s future.