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What Types of Due Diligence Do Private Equity Firms Conduct?

A due diligence process for a private equity transaction involves a complete background check of a target/investee company. This exercise is conducted to locate the target’s assets and liabilities and identify any operation-related issues. It is important to know these aspects as they impact investment returns. According to the 2022 Global Private Equity Outlook, upcoming opportunities in the industry indicate a bright future for private equity funding. In 2022, the industry is expected to break previous records, surpassing USD1.2tn in value. 

Due diligence conducted by private equity firms is extensive, allowing firms to ascertain the implications of potential investments. It requires significant regulatory and financial insight and involves the mapping of market trends for a successful investment. Given that due diligence can be highly unpredictable, private equity firms need to be as thorough as possible in the given time.

Below, we look at five types of due diligence that private equity firms conduct:

Commercial due diligence

Commercial due diligence involves evaluating a target company’s commercial activities to estimate its growth potential. It is the process of understanding how the company operates in an industry. The investor conducting due diligence must request all pertinent documents from the target company. These should provide complete details on the nature of the company’s business, its subsidiaries, current products/services, and expected expansions or pipeline projects. Some of the areas to focus on include

  • Market position of the targeted company
  • Growth and landscape of the industry in which the company operates
  • Customer and supplier base 
  • Financial performance 
  • Capital intensity

Management due diligence

Evaluating the role of a company’s management in its business is crucial. This would involve taking every chance to engage with the management team to understand them well. The due diligence should be thorough, conducted with the help of private equity consulting. At this stage, personal interaction and Q&A sessions are included to perform background checks. 

Financial due diligence

Financial due diligence refers to determining the financial performance of the business at the level it has been presented. It is focussed on the detailed evaluation of financial information through the analysis of disclosure schedules, minutes, trial balances, bank statements and audit reports. All accounts and their financial indicators and audit reports are compared against the industry standard and analysed appropriately. Metrics such as historical margins, debt, equity and leverage are analysed to determine the sustainability of the revenue and cash flow of the target company.

Legal due diligence

Legal due diligence is primarily confirmatory due diligence conducted by probing into the legal affairs of the target business. Here, PE firms should be confident about material findings to arrive at a valuation. It is necessary to determine the company’s unknown or potential liabilities. This due diligence also includes looking into the company’s compliance with laws and regulatory frameworks.

It covers the evaluation of

  • General corporate information 
  • Governmental and regulatory documents 
  • Financial documents 
  • Litigation documents 
  • Business contracts 
  • Real estate and tangible assets 
  • Employee compensation and benefit documents 
  • Intellectual property 
  • Taxes
  • Insurance 

Technology and IT due diligence

Owing to varying levels of tech sophistication in different businesses, applying a standardised process to determine their dependency on or utilisation of technology is challenging. Their systems that are supported by IT infrastructure can be evaluated for current capacity, capability to scale and security. 

Significant areas of focus for technology components include:

  • Enterprise applications such as enterprise resource planning (ERP), supply chain management and customer relationship management (CRM) 
  • IT staff 
  • Software 
  • Cyber and network security
  • Backup and recovery 
  • Training 

Major documents include memorandum of association, articles of association, public releases of the last three years, material contacts, MCA records, filings with RoC, statutory records, list of creditors, HR-related documents and licenses/approvals.

Due diligence includes examining resolved, pending and anticipated future claims so that the investor does not face issues due to unfavourable litigation. It ensures that indemnities or liabilities do not pass on to the investor. After the due diligence process, private equity consulting firms help to represent the risks and hindrances in the definitive documents.

Firms looking for comprehensive private equity consulting services can connect with Acuity Knowledge Partners for support across their investment lifecycles. The firm is a leader in the industry, with experience of almost two decades, helping clients ensure effective deal sourcing, target evaluation and portfolio monitoring and providing advisory services. PE firms can also get dedicated support for fundraising initiatives, fund valuation, client presentations, factsheet generation, RFPs/RFIs/DDQs and investor reporting.

Eleena Wills
Hi, I’m Eleena Wills. Being a writer and blogger, I strive to provide informative and valuable articles to people. With quality, constructive, and well-researched articles, one can make informed choices. I cover a wide range of topics, from home improvement to hair styling and automotive.
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