Private equity funds are shifting away from asset due diligence toward value-focused due diligence. Historically, the due diligence (DD) process centered around an audit of a portfolio company’s assets. Now, private equity (PE) firms are adopting value-focused DD strategies that are more comprehensive in scope and focus on revealing the potential of an asset.
Data analytics are key in support of private equity groups conducting value-focused due diligence. Investors realize the power of data analytics technologies to accelerate deal throughput, reduce portfolio risk, and streamline the whole process. Data and analytics are essential enablers for any kind of value creation, and with them, PE firms can precisely quantify the opportunities and risks of an asset.
The Importance of Taking a Value-Focused Approach to Due Diligence
Due diligence is an integral phase in the merger and acquisition (M&A) lifecycle. It is the critical stage that grants prospective investors a view of everything happening under the hood of the target business. What is discovered during DD will ultimately impact the deal negotiation phase and inform how the sale and purchase agreement is drafted.
The traditional due diligence approach inspects the state of assets, and it is comparable to a home inspection before the house is sold. There is a checklist to tick off: someone evaluates the plumbing, another looks at the foundation, and another person checks out the electrical. In this analogy, the portfolio company is the house, and the inspectors are the DD team.
Asset-focused due diligence has long been the preferred method because it simply has worked. However, we are now contending with an ever-changing, unpredictable economic climate. As a result, investors and funds are forced to embrace a DD strategy that adapts to the changing macroeconomic environment.
With value-focused DD, partners at PE firms are not only using the time to discover cracks in the foundation, but they are also using it as an opportunity to identify and quantify huge opportunities that can be realized during the ownership period. Returning to the house analogy: during DD, partners can find the leaky plumbing and also scope out the investment opportunities (and costs) of converting the property into a short-term rental.
The shift from traditional asset due diligence to value-focused due diligence largely comes from external pressures, like an uncertain macroeconomic environment and stiffening competition. These challenges place PE firms in a race to find ways to maximize their upside to execute their ideal investment thesis. The more opportunities a PE firm can identify, the more competitive it can be for assets and the more aggressive it can be in its bids.
Value-Focused Due Diligence Requires Data and Analytics
As private equity firms increasingly adopt value-focused due diligence, they are crafting a more complete picture using data they are collecting from technology partners, financial and operational teams, and more. Data is the only way partners and investors can quantify and back their value-creation plans.
During the DD process, there will be mountains of data to sift through. Partners at PE firms must analyze it, discover insights, and draw conclusions from it. From there, they can execute specific value-creation strategies that are tracked with real operating metrics, rooted in technological realities, and modeled accurately to the profit and loss statements.
This makes data analytics an important and powerful tool during the due diligence process. Data analytics can come in different forms:
- Data Scientists: PE firms can hire data science specialists to work with the DD team. Data specialists can process and present data in a digestible format for the DD team to extract key insights while remaining focused on key deal responsibilities.
- Data Models: PE firms can use a robustly built data model to create a single source of truth. The data model can combine a variety of key data sources into one central hub. This enables the DD team to easily access the information they need for analysis directly from the data model.
- Data Visuals: Data visualization can aid DD members in creating more succinct and powerful reports that highlight key deal issues.
- Document AI: Harnessing the power of document AI, DD teams can glean insights from a portfolio company’s unstructured data to create an ever more well-rounded picture of a potential acquisition.
Data Analytics Technology Powers Value
Value-focused due diligence requires digital transformation. Digital technology is the primary differentiating factor that can streamline operations and power performance during the due diligence stage. Moreover, the right technology can increase or decrease the value of a company.
Data analytics ultimately allows PE partners to find operationally relevant data and KPIs needed to determine the value of a portfolio company. There will be enormous amounts of data for teams to wade through as they embark on the DD process. However, savvy investors only need the right pieces of information to accomplish their investment thesis and achieve value creation. Investing in robust data infrastructure and technologies is necessary to implement the automated analytics needed to more easily discover value, risk, and opportunities. Data and analytics solutions include:
- Financial Analytics: Financial dashboards can provide a holistic view of portfolio companies. DD members can access on-demand insights into key areas, like operating expenses, cash flow, sales pipeline, and more.
- Operational Metrics: Operational data analytics can highlight opportunities and issues across all departments.
- Executive Dashboards: Leaders can access the data they need in one place. This dashboard is highly tailored to present hyper-relevant information to executives involved with the deal.
Conducting value-focused due diligence requires timely and accurate financial and operating information available on demand. 2nd Watch partners with private equity firms to develop and execute the data, analytics, and data science solutions PE firms need to drive these results in their portfolio companies. Schedule a no-cost, no-obligation private equity whiteboarding session with one of our private equity analytics consultants.