Due diligence is a process of assessing the target company for the purposes of acquiring it (M&A transaction) or investing into it (private equity / venture capital). This is a complex exercise which combines several workstreams including financial, commercial, technology, operations and legal topics. While this might seem like a daunting task, a typical investment deal team is supported by several external advisers (lawyers, accountings, consultants) who act as experts in their respective domains and also uses a variety of software tools to help with the analysis.
Below we will dive into each of the workstreams and cover the main topics of diligence as well as the software tools and advisers typically used by PE/VC funds.
One of the first things to understand in learning how to perform due diligence on a private company is the differentiation in various DD workstreams, which can be broadly split into two categories: (i) exploratory due diligence and (ii) confirmatory due diligence. Exploratory DD addresses topics that "go to value", e.g., findings around commercial and financial aspects of the business that materially impact how the business is valued (from an EV or equity value point of view). Confirmatory due diligence addresses other important, however slightly more technical topics such as legal, regulatory compliance, insurance, etc. Confirmatory topics can also impact valuation if something is not in order, however are not the primary focus for the dealmakers.
The two most important areas for investors are typically Commercial DD (CDD) and Financial DD (FDD) as these workstreams cover the most pertinent topics, relating to the competitive differentiation of the company and its long term growth potential. As a result CDD and FDD usually receive a disproportionate amount if deal team's time and financial resources.
To learn more about applying software and latest data science techniques for PE, check out our Private Equity solutions hub
Commercial DD is a core area of any due diligence on a private company and deals with answering the question of "does this business have a sustainable commercial position and value proposition in the long term?". This workstream is typically performed by a combination of external consultants (e.g., McKinsey, Bain, BCG, Deloitte, others) and internal resources within the PE/VC fund who oversee that work. The typical questions answered in this workstream are listed below:
In order to answer these questions, consultants perform primary research through expert interviews (delivered by the likes of GLG, GuidePoint, AlphaSights and ThirdBridge) and market research through surveys and panels. The consultants also review and extract information form various industry reports and publications in order to form a view on the long term outlook of the market and the target company.
While commercial DD focuses on all things business, market and product, Financial DD is focused on the domain of financial figures and accounts. Even more so than CDD, this workstream is typically delivered by external advisers, (e.g., KPMG, EY, PwC or specialist accountancies) due to the very technical nature of some of the work involved, which covers the following topics:
Management due diligence is a key workstream when learning how to perform due diligence on a private company. This task has historically been done on qualitative basis or through in-person interactions of the deal team directly with management. However as the PE market becomes more sophisticated and more tools become available, MDD has become a separate workstream in its own right, typically performed by a senior deal team member (e.g., Partner) or a trusted advisers specialising on this area. Typical questions covered in MDD are listed below:
This workstream is frequently supported by head-hunters or staffers who can help with finding and appropriate Chairman, or Non-Exec Director for the business and fill other senior roles.
Valuation / Exit is the domain of investment bankers who can help the new owners understand how the business should be valued (e.g., EV/ EBITDA or EV/Sales multiples) and what kind of parties can be expected to want to invest in this business in 4-6 year's time. M&A advisory banks are particularly well-suited for this role as they have access to historical valuation benchmarking from prior deals and can have deep industry connections.
In describing how to do due diligence on a company, we cannot avoid to mention all of the workstreams related to technology and IT. Interestingly, this area has historically been a part of FDD as most of the early IT systems in businesses were developed to support financial reporting and accounting. As the modern day IT stack has evolved to take over pretty much every aspect of business operations this workstream has also grown in importance. For business that are not tech / IT in their core (e.g., manufacturing, or consulting services), Tech DD is usually confirmatory in nature and is used to identify any obvious gaps that need to be improved. For technology based businesses (e.g., e-commerce or SaaS software) this area becomes a core part of the research process and sometimes closely overlaps with CDD as it related to competitive differentiation vs. other players in the market. Similarly to CDD this is usually done by a combination of senior internal advisers (e.g., ex-CTO of a portfolio company) and external providers who specialise in this niche. Most consulting houses will offer a product in this as as well (e.g., Deloitte, Accenture, etc.)
The due diligence process for a private company is never easy, but that doesn’t mean it has to be inefficient or manual. With the proper software and tools in-place, diligence can be straightforward and productive. After all, the information that is discovered during diligence is critical to a deal’s success. Due diligence software like listAlpha, equips teams with the proper tools to be thorough, yet efficient, and to close deals faster.
We tailor your onboarding experience to match what you're looking for. Tell us more about yourself and your team to help us out.