Due Diligence Process

Private Equity

When a private equity firm is considering buying a company, they go through a detailed process called due diligence to make sure the investment is sound. This process usually includes several key steps:

• General Industry Research: The firm studies the industry where the target company operates. They look at trends, competition, and financial health to understand how the company fits in and what its future might hold.

• Quality of Earnings (QoE) Analysis: The firm examines the company’s true earnings potential by analyzing cash flow, identifying recurring versus one-time expenses, and assessing the impact of losing key customers. This helps them understand how profitable the company is likely to be in the future.

• Evaluating Potential Returns: The firm looks at how much profit they can potentially make. They analyze financial metrics, leverage possibilities, and operational improvements to determine if the investment will yield good returns.

• Legal Due Diligence: The firm reviews the company’s legal standing to uncover any risks, such as ongoing disputes or contract issues, that could impact the deal. They also check for regulatory restrictions that might affect operations.

Private Debt

When a private debt firm is considering lending money to your company, they conduct a thorough due diligence process to ensure you can repay the loan. Here’s a simplified outline of the key steps:

• Investment Memorandum & Presentation: The process begins with signing a non-disclosure agreement. You'll then present an overview of your business, including management structure, products/services, market research, growth plans, and how the loan will be used. This helps the lender understand your business and assess whether it's a sound investment.

• Data Room: You'll need to provide all necessary documents including financial statements, contracts, and other key records. The investor’s advisors review these to identify any risks or issues that could affect the deal.

• Creditworthiness: The lender focuses on your ability to repay the loan. This involves reviewing your commercial contracts, client base, assets, and existing debts. They want to ensure your financial foundation is solid enough to handle the new debt.

• Assets and Securitization: The firm reviews your assets, both tangible (like machinery) and intangible (like intellectual property). They check whether these assets are owned or leased and if they’ve been used as security for other debts.

• Direct Sales: Your sales process is scrutinized, including sales cycles, conversion rates, customer pipeline, and marketing strategies. The lender wants to ensure your revenue generation is strong and sustainable.

• Corporate Documents & Legal Litigations: The lender reviews your corporate documents, such as shareholder agreements, director lists, and meeting minutes. They also examine any past or ongoing legal disputes that could pose risks to the loan.

• Employees and Property: The firm reviews your employee data, including staff roles, contracts, and organizational structure. They also assess property-related documents, like lease agreements, to understand your operational costs.

• Other Considerations: Additional documents, such as insurance policies, may be required. The lender wants to ensure all aspects of your business are covered and that there are no hidden risks.

Real Assets

When investing in real assets, a thorough due diligence process ensures a sound investment. We'll focus on real estate as an example of real assets:

• Pre-offer Due Diligence: Before making an offer, analyze the area and neighborhood by considering factors like population growth, median income, vacancy rates, and crime statistics. Prepare a pro forma financial statement to estimate income, expenses, and future improvements. Also, review financing options to ensure your deal is well-structured.

• Post-offer Due Diligence: Once your offer is accepted, conduct physical inspections of the property, including structural, utility, and environmental checks. Review financial records such as profit and loss statements, rent rolls, and leases to verify the property’s performance. Lastly, address legal and loan issues by checking HOA rules, pending litigation, and ensuring the property’s title and appraisal meet your expectations.