Private Equity-Level Due Diligence
Title says it all. Private equity-style diligence is known as being "super deep". As someone who never worked in PE, looking to learn more about what sort of work that actually entails and how you go about doing it all. You've got perfect company-level information, unlike in the public markets. But what sort of work/analysis do you do. TAM, market sizing & industry/market research, deep analysis into competitors, seeking out primary alt data sources, conducting proprietary surveys? Hire Bain's PE Group to help out with all this?
The typical DD streams include:
Based on the above the role of a PE professional when evaluating a target is wide and lots of moving pieces.
These are great workstreams, but it seems like you would hire consultants, accountants, tax professionals, and lawyers to do those DD streams, so I guess my follow up would be what does the PE investment professional dig into with respect to diligence (obviously they make the model, etc.)?
Yes, that's right. An important skillset is briefing, creating access via management, managing and importantly interpreting the interim and final outputs of these service providers. This is why strong process orientation is important.
The actual "direct" work would be writing the investment recommendation paper, building the model, negotiating price with the target, negotiating legal docs (commercial aspects, with support from legal team) etc.
Yes you do hire the external support for these workstreams but good diligence doesn't stop at taking their work for at face value. It's important to independently synthesize and understand their findings and draw/challenge conclusions so that you are bottoming out every possible risk and not 100% leaning on the support to provide you with accurate findings.
That being said, in reality the PE diligence process can be skewed especially in time-sensitive or competitive processes where a deal just needs to get done according to the senior guys. You'll be surprised how many bad investments PE firms make even when diligence has not fully supported moving forward with confidence. Belief in the upside and/or one's ability to turn things around can sometimes lead to an overoptimistic view.
Im doing Corp Dev right now so not PE but our process is basically the same as described above with some added things like HR and IT diligence for integration. You're correct in that you rely on outside parties for the deep dive. However, once you get those reports and information it becomes more important that you can digest everything and piece it all together. You begin to start looking for specific flags or issues and then try to press harder on those until you can flesh out everything and feel like you're confident with the business and it's risk factors. Keep in mind the diligence teams you're hiring are only keyed in on one aspect of the deal. Need people who have a better view of everything to review and decide based on the facts what you agree with or want and what needs to further be investigated. It can be little things like this company has an extremely high revenue concentration. How will we determine the riskiness of that revenue stream going away and how would we protect our down side (Start reviewing specific contracts related and coming up with further diligence questions). Or even things like based on previous similar transactions, we believe their infrastructure is sub-par, we know they will need to hire an additional x amount of employees in these departments lets now go and bake this into the QoE. It really is kinda just piecing everything together from the macro level.
I disagree that you have ‘perfect company level information.’ Frequently, the information you get is partially filtered or lacks context until you speak to management. The provided information will not cover all the potential risks so you have to dig into those areas and request information that you might not get especially if it is a competitive process.
On the CDD aspect - consultants are working off of their own hypothesis for the business, so there is a level of skepticism you need to apply to the output. Even MBB gets things wrong.
Yes I guess that's true. I just meant like you get private financials and granular data at the customer-by-customer level or whatever so you see a detailed financial picture. And I guess part of the art of the DD is asking for more data requests based on where you think any potential bodies are. And I guess you also then apply your own view to the CDD output that McKinsey/Bain gives you?
To add additional color here, I'd note that the CDD process can differ materially for each fund. This is particularly true when comparing fund sizes. For example, I've found that LMM funds are more likely to conduct the commercial work streams themselves (TAM, industry research, competitive landscape, etc. - as you've mentioned). This is at least true at my LMM fund and direct LMM peers. The diligence here can get quite deep, including the potential for juniors to conduct interviews with industry experts or conduct general surveys (e.g. calling a large sample of businesses/customers across your targeted geography to understand their experiences and rationale).
This is an interesting dynamic because you still need to quarterback other work streams that you've outsourced for (FDD, LDD).
Agree this can really vary by fund and team strategy. Work in MF PE and have done a disgusting amount of customer calls, we don’t like using consultants to do this work in most instances (though we’ll use them for more specific diligence topics)
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