Due diligence in private equity

Fullstop22's picture
Rank: Monkey | banana points 37

How relevant is vendor due diligence review in the private equity process when going through the deal - vs say the legal documentation (reviewing purchase agreements, NDAs, credit agreements....).

How detailed do you need to go into the commercial and accounting documents (ie VDD) and what do you do with the information?

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Comments (9)

Best Response
Feb 17, 2018

If it's a distressed deal and the supply chain is broken, it's a big deal. If supply chain is strong and they're all getting paid, not as much. If retail, where you can buy from anyone, not so big unless the store is built around a brand of two. If industrial you might have a sole-supplier or two that can hold you hostage. Solvency of critical suppliers is an issue, you can't trust D&B reports. If you know what you're getting into, the details of purchase agreements wont surprise you. If you've never sold to the big-box stores, you'll be horrified at the T&Cs in the PA. I can go on with landmines, it's all important enough to look at but much more efficient if you know what you're looking for.

Good Luck.

    • 3
Feb 18, 2018

Thank you for the answer. I guess I should clarify further.
When as a private equity associate / VP receives a VDD report for a potential target - let's say its an industrial company and non-distressed transaction.

What task does the associate / VP have to do to analyze the company. How thourogh and deep do you go. I guess I'm asking how do you read a VDD and get the most relevant information out of report that could be 200 pages long.

Focus on customer concentration? Look at working capital requirements? What the components of debt are? Would'nt I get all this information from Confidential Information memorandum?

For a purchase agreement its kind of straightforward but I'm a little weak on the VDD part.

Thank you for your help.

Feb 19, 2018
Fullstop22:

Thank you for the answer. I guess I should clarify further.
When as a private equity associate / VP receives a VDD report for a potential target - let's say its an industrial company and non-distressed transaction.

What task does the associate / VP have to do to analyze the company. How thourogh and deep do you go. I guess I'm asking how do you read a VDD and get the most relevant information out of report that could be 200 pages long.

Focus on customer concentration? Look at working capital requirements? What the components of debt are? Would'nt I get all this information from Confidential Information memorandum?

For a purchase agreement its kind of straightforward but I'm a little weak on the VDD part.

Thank you for your help.

In my experience, expect to read every page of the Financial DD. It will then be up to you (at least initially) to spend either 10 seconds or 10 minutes on a specific page. Where you would focus really depends on the business and what you are looking for, but usually it would be a mix of EBITDA adjustments, Net Debt adjustments, WC adjustments, profitability by products/business line, like-for-like evolution of the business (if very acquisitive, or for example a retail chain opening new stores every month). Working capital evolution/seasonality, FX volatility (and its impact on historical figures), and many other useful things can be found in the vendor FDD. It gives you useful information to then tailor your buy-side advisor.

Regarding Legal (often together with Labour/HR) DD, I personally spend a lot less time reading it, your legal advisor will go page by page of all important documents and contracts. You will probably know beforehand what you would like to focus on (e.g. a specific lease of a key location generating 80% of your EBITDA, a key supplier contract, cancellation rights of customers deposits, etc).

    • 2
Feb 20, 2018

Thanks good stuff !

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Feb 20, 2018

jimbrowngoU,

Are you talking about the internal DD process where the investment bank diligences the company and then writes the offering memorandum, or are you talking about the external DD process where prospective acquirers diligence the company? While both are important, the internal due diligence is far more critical than the external DD.

While having gone through the Due Diligence process in itself is not absolutely critical for PE recruiting, not having it tells me that you have not seen a deal from start to finish. And while I've seen a number successful candidates without any closed deals, you're certainly at a disadvantage. Also, it depends on the role of associates at the PE shop you're interviewing at. If the role is primarily cold-calling/sourcing, they likely won't hold it against you. If you're expected to be in the weeds and managing 3rd party DD providers, this will significantly hinder your success.

Feb 20, 2018

I'm talking about external DD. I've completed a couple of deals from start-to-finish that involve information memos, though they were not all M&A. One was a convertible debt offering, a convertible P/S offering, and one sell-side M&A (out of curiosity, will the PP due diligence process "count" in terms of internal DD? The process is basically exactly the same as the sell-side M&A).

As far as deals, I have seen three from start-to-finish (closed four), and all three involved DD to write CIMs. Will this be a disadvantage for recruiting?

I have done a little external DD, but at this point it has been more of me sitting in with a VP/listening in on a call than actually running the DD.

Feb 20, 2018

Internal due diligence done by an Ibank is considered as digesting by the buyside, ie take raw numbers and place them in an understandable format. Banks really just prepare info for the buyside to analyze... What the buyside uses the numbers for and how is more critical since, well they're buying the asset. These figures ge digested by the buyer and all their consultants running all type of DD from strategic, to legal, to environmental and you get the picture... On top of that, 99.99% of the rime, management lowers the assumptions when the buyer gets involved telling you the banks diligence was just for marketing purposes..

Feb 20, 2018