Data from Crunchbase reveals that while private capital deal volume dropped to historically low levels in 2023, late stage funding has begun its rebound. More deals are being done, and this increases competition in a market where the qualifier for a "high quality deal" has narrowed significantly.
Finding deals that produce a return on investment is not an easy task. That’s where an effective due diligence process—not just deal origination—can be a differentiator for a private equity (PE) firm.
Conducting due diligence is how PE deal teams figure out if a deal is worth pursuing, or if it’s time to walk away. The average PE firm evaluates 80 deals before investing in a single company—and closing a deal takes an average of 20 meetings, four negotiations with target companies, and 3.1 full-time deal team members. So winning firms are the ones that can conduct due diligence this quickly and comprehensively.
Once your PE deal team has identified a potentially good deal, it’s time to conduct thorough due diligence. Your team is looking for information around the target company’s financials, legal aspects, IT, operational processes, and so much more. It’s critical that your firm has a process for this complex task so you can minimize the risks when investing in a privately held company.
Private equity investments are complex deals with long time horizons—and your firm’s private equity funds, time, resources, and reputation are on the line. Follow the advice in this article to evaluate all the right factors, mitigate risks, and find strong companies for your limited partners to invest in.
You’ll learn more about private equity due diligence best practices. You’ll also find a PE due diligence checklist template that your deal team can use as a starting point to improve and accelerate your PE firm’s due diligence process.
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What makes the private equity due diligence process unique?
The purpose of due diligence may be the same for private equity as it is for other investment teams: to minimize risk and maximize value for investors. But many of the focus areas differ from venture capital and investment banking.
To improve the odds that a PE deal will yield a return for your firm and its LPs, your deal team must gather information about the target company, the seller, and the assets for sale, then put together the best purchase plan and price. The due diligence strategy for a PE deal will be driven by the PE fund’s investment thesis and strategy for building value.
Much of the private equity due diligence process is guided by the confidential information memorandum (CIM). This is a long document—often upwards of 50 pages in length—that the seller provides that includes information like:
- Basic financial data
- Overview of the management team
- Competitive landscape
- Products, services, and pricing strategy
- Customer base
Because the CIM can often be so long, it can appear at first glance to be comprehensive. But smart PE deal teams don’t rely solely on the CIM to make investment decisions. Rather, they use the CIM as a starting point for further due diligence.
What private equity firms look for in an opportunity is different from venture capital in many ways—but one primary difference is that while VCs are looking for strong founders and strong company performance, PE firms are often looking for problem areas. The firm can get a better deal on a company that has problems that the PE firm can fix.
An underperforming management team is an example of a fixable problem. If the PE firm can acquire the struggling company at a discount, they can likely add value and improve performance by coaching or replacing the management team. This information is likely not in a CIM, however, and can only be uncovered by a savvy PE deal team that meets with managers, visits suppliers, and interviews customers.
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Pass/fail screening questions for PE deal teams
The first thing a smart PE deal team will do is compare a potential investment against the fund’s investment criteria. Some companies can be immediately dismissed based on their financial profile, geography, or industry not aligning with the PE firm’s focus areas.
If the company passes that initial inspection, however, further criteria that may screen out potential bad fits include:
- Revenue growth
- Market position
- Management team track record
- Sustainable competitive advantages
- Stable cash flow
- Maintenance capital expenditure requirements
- Favorable industry trends
- Multiple avenues of growth
PE due diligence can be a lengthy, complicated process, so the faster you can say “no,” the more time you can spend doing due diligence on companies that will turn a profit for your firm. Affinity helps accelerate this process with two types of insights that are easily accessible from Affinity company profiles. Employee Growth Insights reveals data on prospect company headcount growth and churn, while Industry Insights provides AI-driven information about competing and related companies.
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What is a private equity due diligence checklist?
A PE due diligence checklist is a tool your deal team can use to gather information on, assess, and analyze potential PE deals.
A typical due diligence checklist for private equity will include finance, legal, tax, management team, and assets—but depending on the PE fund and the target company industry, you will likely add more categories to your due diligence checklist. For example, unlike VC firms, you’ll want to take a closer look at the management team and cash flow.
Your private equity due diligence checklist should be as comprehensive as possible and help you make as informed of a decision as you can. Some of the questions and requests for information will need to be sent to the seller in a due diligence questionnaire, but your deal team can also gather many of the data points in a desk study.
Which parts of due diligence does this checklist include?
Most VC due diligence checklists will cover these basic areas:
- Finance
- Tax
- Legal
- HR
- Assets
- IT
- Competitive position
- Total addressable market (TAM) and customer base
- Capital requirements
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PE due diligence checklist
Use this checklist template as a starting point for your PE deal team’s comprehensive due diligence checklist. Be sure to put your final checklist in a centralized, shared location (like your customer relationship management platform). so everyone in your firm can stay on the same page.
Finance
A company’s financial information tells the story of the dynamics of the company, and financial due diligence may be the most important area of focus for PE firms. It can also take the longest amount of time to gather all this information.
- Historical financial performance
- Financial projections
- Current financial statements
- Balance sheet
- Sales reports
- Outstanding contracts (for supplies, materials, etc.)
- Inventory
- Accounts payable
- Schedule of bad debt and/or write-offs
- Current accounting system
- Any funding by VCs
Tax
PE deal teams can analyze the target company’s tax situation to uncover ways to maximize profit and minimize tax liabilities.
- Tax structure
- Federal tax returns from the last three years
- State and local tax returns from the last three years
- Any correspondence with tax authorities since the founding of the company
- Research and development credit reports
- Schedule of comprehensive tax examinations and audits in the last 5 years
Legal
The legal due diligence questions you’ll ask of the seller are mainly to confirm that the company is not subject to current or future liabilities.
- Location of the company’s headquarters
- Corporate filings
- Antitrust and regulatory issues
- Compliance with statutes and regulations
- Environmental issues
- Insurance coverage
- Licenses and permits
- Pending litigation
- Articles of incorporation
- Bylaws and amendments
- Annual reports
- Listing of shareholders and percentages owned
Human resources
A deal team will want to look closely at management structure, employees, and benefits to uncover any problem areas.
- Organizational structure
- Management team
- Current employees, employment agreements, and salary schedules
- Collectively bargained agreements
- Current contractors, consultants, and other outsourced professionals and service providers
- Benefits packages
- Workers comp and unemployment claims history
- Resumes of employees
- Nondisclosure agreements
- Future hiring plans
- Open offers of employment that have not yet been accepted
Assets
In this section of the checklist, the PE deal team will get information on the tangible and intangible assets of the company, including intellectual property, real estate, inventory, and equipment. This can also give your firm an idea of the liquidity of the company.
- Real estate (both owned and leased properties)
- Inventory in the current period
- Equipment (both owned and leased)
- Schedule of fixed assets with location
- Trade secrets
- Copyrights
- Patterns
- Trademarks
- Industrial designs
- Any other assets
Information technology
All information technology hardware, software, and plans should be accounted for in the IT section of the PE due diligence checklist.
- Software and hardware used by the company
- Software licenses owned
- Analysis of current IT system
- Data management and data security practices
- Agreements with outside IT companies
- Documentation of disaster recovery plan
Competitive position
In this section, the deal team will learn about the company’s revenue streams, market position, competitors, and products and services.
- Current products and services
- Planned products and services
- Discontinued products and services
- Sales volume by product and service
- Profitability of all products and services
- Market share by product and service
- Analysis of potential future market share
- Any regulatory documentation related to products and services
- List of main competitors
- SWOT analysis (strengths, weaknesses, opportunities, and threats)
Total addressable market and suppliers
In this section, your PE deal team will get information about the company’s customers and suppliers.
- Customer information, including contracts and invoices
- Standard contract length of a customer relationship
- Customer churn rate
- Customer lifetime value
- Cost to acquire a customer
- List of suppliers
- Average length of a relationship with a supplier, and how often are contracts renegotiated
- Any current or future supply chain issues
Competition
Before a deal team can determine if a company is worth investing in, they should get a good understanding of the capital needed to maintain operations.
- Normal level of working capital required to run the business
- Breakdown of capital expenditure versus operational expenditure
- Breakdown of fixed versus variable COGS
- Cycles and seasons of demand
Founder background
The management team may make the biggest difference in a target company’s future success as your PE firm’s portfolio company.
- Professional background of each of the management team members
- Qualitative assessment of the management team’s performance, strengths, and weaknesses
- What the management team says they need from a buyer
Secure better deals with a PE due diligence checklist
With an effective due diligence checklist for PE, your deal team can ensure that no critical information is overlooked. And with the comprehensive due diligence report generated by a thorough diligence process, your deal team and GPs can evaluate an investment opportunity with confidence. Use this private equity due diligence checklist template as your starting point to guide your decision about proceeding with a purchase or walking away from a deal. You’ll be in a better position to make wise investment decisions and prove your firm as a high performer for LPs.
Before you ever reach the due diligence stage of evaluating potential investment opportunities, however, there are innumerable workflows that make up the pre-diligence process. Relationship intelligence CRM platforms like Affinity support your team by:
- Automating contact data capture
- Supporting deal sourcing
- Helping nurture existing relationships and build new ones
- Managing high quality deal flow from start to finish
- Providing access to manage meetings, networking activities, and deals from a mobile device
Learn how relationship intelligence can make a difference for your firm before you even start your due diligence. Talk to an Affinity team member today to learn more.
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