Produced by (E) BrandConnect
There is a perception that due diligence exists to ensure that a potential acquisition is what it appears: an independent validation of company numbers and of the market and company’s stability.
If it was ever thus, it certainly isn’t now. “It was easier to make money before the crisis,” says Fredrik Burger, private equity operating partner at EY UK & Ireland in London. “The cliché then, that it was sufficient to ‘leverage and luck’ in order to make a return, is totally inadequate today. It’s now much more about generating a transformative investment thesis.”
Private equity firms need a differentiated vision that allows them to both be the best buyer for the target, but also execute that vision to generate attractive returns. The diligence process guides the investment thesis.
Many moving parts
The inability to generate a workable thesis has costly implications. EY research demonstrates that insufficient diligence, combined with a lack of understanding of the top-line, was one of the main reasons for the suboptimal performance of private equity deals.
The best way to conduct the right kind of diligence today is deploying an integrated approach. This helps deal partners identify and resolve key risk areas and uncover new opportunities, in addition to saving time and money.
This approach is a multifaceted process, covering financial, tax, operational, commercial, legal, human capital, IT and cybersecurity. All of these elements need to mesh seamlessly to provide potential acquirers with a comprehensive understanding of the enterprise. This approach creates a set of coherent and dispositive insights and avoids dangerous blind spots and inconsistencies in the diligence.
Some private equity firms approach diligence by tapping their incumbent providers in each of these distinct areas, using one firm for commercial due diligence, another for financials and so on. Done this way, however, the whole can never be more than the sum of its parts.
In cherry-picking several firms for each phase of the diligence process, private equity firms run the risk of having unrecognized gaps in the data — inconsistencies from one area to another — resulting from differing methodologies and owners. And they won’t gain from new and differentiated insights that come from an integrated, connected team.
Better insights through integration
Integration gives a more holistic perspective, offering a clear look-through of the business using a consistent data set. Thus, the investment thesis can be tested against the various deal drivers, from commercial to cyber, all working from a common fact base. Perhaps more important, each of these different areas can inform the other, cross-checking for inconsistencies and highlighting problems that might have been missed in handoffs between diligence providers.
The advantages of an integrated approach are tangible, directly impacting the viability of a deal. EY recently advised a client during a consumer durable acquisition that threw up a red flag. “Our financial team saw considerable margin pressure in one area of the $2b business, but it wasn’t clear what was driving it — the market or the firm itself,” explains Andres Saenz, EY-Parthenon Co-Head of Private Equity.
“After our financial and commercial teams discussed the issue, the commercial team modified their approach and conducted several interviews with market buyers and competitors. They came to the conclusion that the firm was discounting aggressively to take market share. The margin softness was a self-inflicted, but reparable, wound. Knowing this, the private equity firm could bid at a market-beating rate with greater confidence.”
These sorts of issues are common. They need to be highlighted and resolved early in the process, lest firms miss out on a worthwhile transaction or take on one with problems that might impact the viability of a deal.
According to EY research, some 76% of senior executives at private equity firms said they failed to complete or canceled a planned acquisition in the past 12 months, with 43% citing due diligence issues. Without being able to cross-check quickly, firms can walk away from deals because of eminently fixable problems and lose out on good deals. In today’s ultra-competitive environment, an effective diligence program is a competitive differentiator.
This is where EY has a demonstrable edge — combining big data with its own proprietary information from tax to operational areas. “Everyone in each team is working off the same data set — there are no silos separating financial and commercial, for example,” says Saenz.
Bundling for speed
If having an integrated view of the different facets of diligence is important, being able to deploy the different elements quickly — as and when needed — is also vital. Private equity firms can no longer afford to wait for one element of diligence to be finished and then begin the next.
Like so many other areas of the private equity process, diligence has become a competitive sprint. But quality cannot be forsaken for speed. Firms need to come to a decision quickly, after identifying and resolving problem areas. Integration offers key services quickly, increasing reactivity and reducing costs.
