RESEARCH REPORT
It's time to rethink private equity due diligence
5-MINUTE READ
June 4, 2024
In brief
- Finding and winning deals is getting more challenging. Three in four leaders say that private equity (PE) investments have grown more complex.
- Comprehensive due diligence is key to unlocking a deal’s full potential. Yet, 83% of leaders say their approach has substantial room for improvement.
- We explore three critical approaches that turn traditional due diligence into a more dynamic, value-driven process.
Navigating the deal maze
We believe PE investors need to think about tooling their portfolio companies differently. Deeper changes in business and operating models are often necessary to set up the company for long-term success and realize maximum value.
What’s needed to make these choices with conviction? Knowing the target company inside out. Detailed, granular analysis sets the stage for effective post-deal value creation, helping firms to hit the ground running.
Competitive edge starts pre-deal
75%
of PE leaders say that investments have grown more complex over the past five years.
79%
of a firm’s efforts should target operational value creation, according to leaders.
83%
believe their current due diligence approach has substantial room for improvement.
90%
agree that higher-quality diligence consistently enhances value creation planning.
The pre-deal phase is rising on the agenda
Our analysis of PE firms’ earnings call transcripts and media articles reveals a significant uptick in the discussion of crucial topics such as due diligence, sourcing and screening, and value creation plans. This indicates a heightened focus on pre-deal activities.
This emphasis on due diligence is also borne out by firms’ expenditures. Our survey reveals that PE leaders typically spend approximately 1% of total deal value on such activities. That translates into a potential spend of $80 billion on due diligence over the next five years.
Rather than just ‘getting due diligence done,’ we believe the approach needs to evolve toward ‘making due diligence a competitive edge’ for buyouts. Superior outcomes justify the resources allocated to these exercises.
A new dawn
As the dealmaking landscape evolves, it's clear that a shift in strategy is needed to drive maximum value creation. Developing a robust vision for the target before finalizing the deal is crucial in shaping successful investment outcomes.
Three critical approaches promise to transform the traditional due diligence into a more dynamic, value-driven approach.
1. Get the full view
The discovery of unexpected gaps in the portfolio company’s capabilities, processes or technology is a common occurrence: 40% of our survey respondents see this as a top challenge.
Better and more connected insights pre-deal help develop a stronger, more cohesive value creation plan and can justify higher bid amounts. With due diligence now covering more and broader areas—from technology and operations to leadership and sustainability—an integrated process that paints a comprehensive picture is crucial.
The scope of due diligence has increased
2. Do more with less
Firms that harness advanced technologies in their target screening and due diligence can work faster and drive deeper analyses. Nearly two-thirds of leaders (62%) expect technologies like analytics and generative AI to fundamentally transform their deal screening and due diligence.
As firms ramp up their use of technology, the focus shifts toward strategic applications that push the boundaries of what’s possible in the pre-deal stages.
Generative AI has the potential to automate up to 30% of due diligence tasks and augment an additional 20%, significantly cutting down the time spent on manual processes.
3. Elevate leadership capabilities
Leadership gaps at portfolio companies emerged as an increasingly critical obstacle for value creation. Nearly half of the leaders (47%) listed this among their top three challenges for value creation execution. Lack of cultural readiness is also a significant obstacle, ranking in the top three for 36% of respondents.
As rapid advances in technology become a key disruptive force, chief executives with a technology background are better equipped to manage change, regardless of industry. Our analysis shows that CEOs with technology experience delivered a five-year revenue CAGR of 23.9%, 1.4x more than CEOs without such a background.
Understanding the CEO and the leadership, assessing the team, their capability and track record are all key aspects of due diligence.
Director / US-based PE firm
As dawn breaks, so do the barriers to opportunity
The due diligence process has traditionally focused on evaluating an asset’s viability, risks and alignment with the PE firm’s investment strategy. Pre-deal value creation planning enables investors to clearly ascertain if the target company has the necessary resources and operating model to pull the agreed upon levers. It allows firms to move faster and bring in the capabilities and leadership needed to manage the change.
