It is often mused that the success of an investment is directly proportionate to the rigor of the initial analysis. Whether this is true or not (there’s always the risk of analysis paralysis), private equity firms expend an inordinate amount of effort on determining the viability of a potential investment. The following list, although not exhaustive, describes some common forms of due diligence (DD) in private equity:
- Commercial: initially, the private equity team conducts this internally. It begins with the construction of an extensive questionnaire delivered to and completed by the management team. The questionnaire requests information on structure, offerings, financials, insurance, employees, etc. The private equity team will then perform extensive analysis on this data to determine whether they will proceed with paid analysis e.g. expert interviews and engaging management consultants.
- Financial / Accounting: this analysis attempts to verify the accuracy of accounts and to glean important financial information that can support the investment decision. The analysis will discuss margins, working capital, capex, forecasts, trends in expenses, diversification of revenue streams, etc.
- Tax: this is similar to accounting due diligence, but focused specifically on statutory taxation and outstanding tax liabilities. Tax analysis will also uncover ways to structure the deal and run the business in the future.
- Legal: this is mostly concerned with the structure of the business and its legal operating entities. The output will discuss charges against assets, property leases, commercial & employment contracts, intellectual property, and any outstanding litigation. Often the legal due diligence team also handles the preparation of the transaction documentation since it already understands the business.
- Insurance: although often overlooked, insurance due diligence is an important part of risk management for a private equity firm. It is mostly concerned with understanding the ideal level of insurance for a business and comparing that to the current level of insurance. Another major consideration is the ongoing exposure to potential claims based on events from the past.
- Industry / Market: the private equity firm or external industry experts will conduct this, depending on the firm’s internal skill set. The purpose is to determine the position and value of the business from the perspective of an industry professional. It is especially useful in industries that command a specialised skill set.
- Other: a multitude of other types of private equity due diligence, such as environmental, social & governance (ESG) and ethical, are considered on a case-by-case basis and in consultation with the team and their respective skills.