Private equity businesses are made of investors who aim to gain returns from purchasing into companies instead of investing bonds or stocks. Practically, the target companies are often financially struggling but still got remarkable positive aspects as determined by the investors of private equity. These companies simply require cash infusion and perhaps an extra dose of restructuring or management expertise to make the operation more efficient. Every time an individual or a business decides to make a fresh acquisition, it is highly recommended that they perform due diligence. And while the company can utilize the investors or the fund managers to do it on their own, it is better to hire experts to do due diligence because of the intricacy of the process.
Why Is It Important?
In the business world particularly in finance, private equity due diligence is a significant term. While some call it an audit or an investigation, the process entails fact-checking and comprehensive research of a particular investment or product. Some business parties like brokers are mandated by law to conduct due diligence. However, for private and individual investors, it is not required. Yet, all buyers and investors are highly advised to conduct due diligence. This is to make sure that their investment will not go south. More importantly, the process will make sure that all bases are covered and no data are concealed. Hidden information is often intentionally omitted because of its negative repercussions. As an investor, you need to know about it to prevent turning your investment into a living nightmare.
Basically, the people conducting due diligence is searching for information that could be detrimental to the investment. This includes damage to reputation or loss of money. For instance, looking at the court records will give you litigation history. Checking on social media accounts could disclose inappropriate drama. Meanwhile, corporate documents reveal the current state of the business. Aside from these, investigators also conduct bankruptcy filings as well as international watch lists. You could be conducting due diligence to be aware of the state of a possible merger or to simply screen a dealer, or to dig into the background of an incoming fund manager. Regardless of your reason, the fundamental idea is still the same.
Due Diligence Methods
While different research and investigative firms have their process and methods of conducting due diligence, it often involves the following:
- Company Capitalization
In this step, investigators collate data to know the general reputation of the company as well as its market value.
- Evaluating Current Margins
Investigators concentrate on the numbers. This includes analyzing the status of the present margins if it is rising, falling, or just stagnant.
- Checking Competitors
In this step, investigators compare the company with its direct competitors. This is very useful and always results in revealing the exact image of the current standing of the company.
- Ratio Examination
This step involves evaluation of the PEG, P/E, and P/S ratios of the company as well as its competitors.
- Managers and Shareholders
This involves studying the pillars of the company and checking on the shares each key executive owns.
- Examining Balance Sheets
Investigators check the debt-equity ratio of the company against its business model. It also includes tracking the cash flow and the amount of debt.
While it is not really necessary to conduct due diligence, it is unwise not to do so. The process could reveal information that could have a massive impact on your decision making. Due diligence is not merely about discovering the skeletons in the closet and finding the deal breakers. It is also uncovering valuable information that could make the deal even more beneficial or profitable. These days, due diligence is considered as one of the most important aspects of deal-making. It is a significant process that the private equity industry and the financial sector utilize.
If you are planning to hire a firm to conduct due diligence, it is important to make sure that you hire skilled and passionate experts to do it. Usually, the entire process lasts for two or three weeks. Due diligence is the best insurance that you can get if you are going to make a major decision. While you have to spend for the entire process, it is important to consider that the price you are paying is usually less than the cost of not conducting one.