Private Equity Merger Acquisition Due Diligence

11 Areas of Due Diligence to Boost PE Acquisition Success

by Amy Julian
June 12, 2024

Due diligence is crucial to inform M&A decisions and guide buyers' next steps, from pricing all the way to post-purchase priorities. But the standard, financial-focused approach means few investors reap the full value that due diligence could provide. A holistic approach goes deeper into current operations by examining areas you may not have considered and connecting the dots to accelerate value creation.

This more complete exploration of a potential acquisition pays off by helping you identify critical value drivers, risks and opportunities to achieve the value hypothesis. The findings can shed light on everything from human capital and real estate consolidation to weaknesses in operations, technology and customer retention that may require investment to achieve the original value proposition.

Traditional Due Diligence Leaves Capital at Risk

Financial due diligence alone often misses the mark — especially in private equity (PE) transactions, where the investment premise hinges on precise calculation of multiple value drivers. It's a major reason why so many M&A deals fail to deliver the benefits investors expect.

Your PE deal team needs to know how to account for the many variables that create profitable portfolio companies. But unanticipated risks in technology, marketing, benefits, operations and other areas can make it hard to achieve the value you banked on. For example:

  • Strong financial statements don't always tell the whole story. A target company with strong financials may not trigger obvious red flags during standard due diligence. What if you discover after closing that poor brand management and client relationships materially altered the value proposition? You missed an opportunity to negotiate the price and publicize the change in ownership.
  • Unrecognized cybersecurity incidents can distort valuation . Financial due diligence might not reveal a previous hacker attack, but this history could lead to a lasting loss of revenue. Besides customer wariness, the target could face legal liabilities, higher insurance premiums and added operational and technology costs.

It's impossible to predict all the ways an acquisition can go wrong, but holistic due diligence uncovers pitfalls that a traditional approach often misses.

Holistic Due Diligence Kickstarts Your Integration Plan

While investors often pursue due diligence with multiple providers, these siloed assessments limit your view of the big picture and prevent effective planning. This fragmented approach makes it hard to address interdependent questions like:

  • What are the most urgent priorities after you close the deal?
  • How does the target's position on the tech maturity curve impact human capital needs?
  • How should the due diligence findings around sustainability questions shape your operational decisions as you roll the new company into your portfolio?

Working with multiple providers puts heavy time demands on the PE firm and makes your deal team responsible for identifying all the interdependencies. Having one provider for all due diligence helps streamline the process.

And, by sharing findings and collaborating throughout the process, a single provider's experts can better identify any issues that demand a closer look and deliver deeper insights about their findings. Holistic due diligence could lead to a change in the purchase price based on deficiencies you found in human capital or operational assessments, for example.

A holistic approach can also accelerate post-close value creation plans by helping the deal team prioritize issues and opportunities that due diligence revealed, such as real estate consolidation or urgent technology upgrades. Your improvement plan becomes faster and more effective when you know which needs to address first.

11 Areas of Due Diligence to Uncover Hidden Risks

You won't know what risks and opportunities a company presents unless you look. Before proceeding with any transaction, you should carefully evaluate your due diligence needs . Sometimes, a few areas are enough to give you a clear picture, while complex acquisitions may require you to pursue due diligence in more of these key areas.

1. Financial: Bolster Valuation Confidence

Investors universally recognize the need for financial due diligence to assess the current financial state of the target's business operations. A thorough revenue review helps you:

  • Determine accurate valuation by identifying and quantifying key risks.
  • Uncover any internal control vulnerabilities.
  • Highlight opportunities to unlock additional value.
  • Reveal scalability and growth potential.

2. Benefits, Payroll & HR: Flag Policy and Procedure Differences

Taking a close look at the benefits, payroll and human resources processes and policies helps your PE firm identify key differences between multiple entities, allowing you to:

  • Plan to promote employee retention and attract new talent.
  • Validate compliance with policies and confirm the need for existing policies.
  • Confirm adequate internal controls and regulatory compliance.

3. Tax: Get the Payoff You Anticipate

The tax implications of M&A can dramatically alter the value equation in any deal, which makes expert advice imperative. Tax due diligence gives you crucial transaction support to help you:
  • Structure the deal and include precise language in the agreement.
  • Negotiate appropriate clauses based on tax findings.
  • Add proper representations and warranties to the share purchase agreement.
  • Identify unused tax benefits and limits on your future use of those benefits so you can adjust the sales price accordingly.

4. IT, Cybersecurity & Privacy: Recognize Tech Needs and Risks

Technology can be a key differentiator in determining risk, value and competitive advantage. Tech-focused due diligence can help you:

  • Identify technology synergies and investment needs — and confirm whether it makes sense to integrate an acquisition's finance tech stack.
  • Gauge how well the current IT team and assets can fulfill your value improvement strategy, along with the difficulty of making necessary changes.
  • Measure cybersecurity risks, deficiencies and privacy-related liabilities, including risks associated with the target's website.

5. Forensic Health Check: Detect and Deter Fraud

Forensic financial health checks can detect red flags that may indicate risk. These under-used due diligence services:

  • Provide a low-cost but robust review and analysis of typical high-risk areas.
  • Allow faster detection of fraud and internal controls deviation.
  • Strengthen compliance, serve as a fraud deterrent and reduce losses through prevention.
  • Offer greater visibility into vendors and spending.

6. Operational Assessment: Accelerate Improvement Planning

Operational due diligence makes it easier to spot opportunities to create additional value. It helps you:

  • Assess how much investment you'll need to make to align a target's operations with your strategic goals.
  • Discern potential supply chain risks.
  • Define scalability based on people, process and operational capacity.
  • Guide strategies to integrate the acquisition smoothly into your portfolio.

7. Human Capital & Leadership: Resolve People Problems Preemptively

Assessing human capital and leadership lets you spot potential leadership team gaps, organizational overlaps and performance differences so you can:

  • Identify potential culture clashes between merging entities.
  • Align and clarify roles and responsibilities.
  • Evaluate leadership styles and pinpoint where complementary skill sets might be helpful (i.e., bring in an operational CFO to support an entrepreneurial CEO).
  • Adjust team composition and provide additional soft and hard skills training.
  • Address interpersonal problems and take other corrective actions as soon as the deal closes.

8. Environmental, Social & Governance (ESG): Quantify Potential Sustainability Risks

With an ESG benchmark assessment, you can gauge the target company's ability to meet regulatory requirements now and in the future. Due diligence on key sustainability issues helps you:

  • Gain greater visibility into operations and supply chain sustainability risks.
  • Identify opportunities to decouple growth from energy usage and emissions and reduce operating costs.
  • See how well the target can satisfy customer expectations around sustainability.

9. Marketing & Communications: Inform Messaging Strategy

Evaluating a target company's marketing and communications helps you understand how effective current strategies are so you can:

  • Determine how current marketing and communications align with your improvement strategy.
  • Spot marketing and messaging-related opportunities and risks.
  • Project future costs associated with various sales channels.
  • Establish a roadmap for internal and operational process adjustments.
  • Get ahead of any change management hurdles before you integrate the teams.

10. Revenue & Customer Intelligence: Extract Value From Data

A target company's revenue data and customer intelligence hold a wealth of opportunities for PE firms. Using predictive analytics and other artificial intelligence (AI) solutions, your due diligence provider can help you extract data-driven insights from these resources to:

  • Forecast trends, identify revenue risks and uncover areas of untapped value.
  • Formulate customized revenue improvement strategies.
  • Establish target-specific benchmarks to measure future success.

11. Strategy & Post-Merger Integration Readiness: Hit the Ground at Top Speed

Pre-acquisition integration planning lets you begin adding value as soon as the deal closes. Skilled due diligence providers can work collaboratively with your team and the target to:

  • Establish key priorities and define success criteria and tracking methodology.
  • Integrate due diligence findings and gap assessments with your improvement plan.
  • Identify differences in organizational culture and plan for addressing disparities.
  • Create strong communications to improve employee retention, smoothly implement new initiatives and minimize customer and supplier concerns.

Integrated Insights Help You Hit the Ground Running

When you work with a single due diligence provider to uncover all potential pitfalls and opportunities, you'll gain deeper and more integrated insights that give you a head start on the execution stage of your potential deal. Armed with this data, you can fine-tune the steps in your value creation plan and accelerate their sequence to create value more quickly.

A provider with expertise in all areas of due diligence can also help you determine key focus points for your transaction so you can direct resources strategically without overlooking material risks.

Accelerate Your Value Creation With Holistic Due Diligence

Don't let the time and money costs of overlooked problem areas or uncoordinated findings torpedo your acquisition value proposition. Connect with our experienced private equity advisory team to assess your needs and unlock more value in the due diligence phase of your next M&A with a holistic approach.

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