Running an Effective Due Diligence Process

As discussed in The Golden Rule of Private Equity Investing, a well defined due diligence process is necessary to ensure successful investment outcomes. Due diligence serves as a critical step in the overall investment process, which we discussed in Formulating an Effective Investment Framework.

What is due diligence?

A due diligence process is a structured and comprehensive investigation or review conducted before finalizing a business transaction, such as an investment, merger, or acquisition. It helps investors or buyers assess the risks, opportunities, and overall viability of the deal.

In the context of private company investing, due diligence is typically a 30-90 day process that takes place prior to the signing of definitive legal documents for the purchase of, or investment in, the target company.

What does due diligence entail?

While due diligence can vary widely depending on factors such as the transaction type, the industry, and the deal/investment size, the due diligence process typically entails:

1. Preparation and Scoping

2. Information Gathering and Review

3. Interviews and Analysis

4. Assessment, Validation and Findings

5. Reporting and Decision Making

What makes a strong due diligence process?

From our experience, a strong due diligence processes:

1. Validates the investment criteria, acquisition thesis, key assumptions, and key risks

2. Defines the post-acquisition integration, operating and value creation plans

The acquisition thesis, key assumptions and key risks will vary on a deal-to-deal basis and form the critical checklist of items that need to be verified for the investment to be successful. The due diligence process is an opportunity to design a tailored approach to validate and get comfortable with everything required for the investment to work.

In instances where the buyer or investor will be taking on an active management role, it is equally important that due diligence is also used to define the post-acquisition plan. A well executed due diligence process sets business operators up for success and allows them to hit the ground running on day one.

Our 10 Guiding Principles for Effective Due Diligence

1. Start with the acquisition thesis; think creatively and formulate a unique process to validate the thesis and key assumptions

2. Set yourself up for success with a comprehensive due diligence checklist and project management tools, trackers and timelines

3. Set realistic expectations and timelines with all parties involved; maintain clear and tight communication throughout the process

4. Prioritize the most critical assumptions and key risks first; focus the early stages of the process on validation and assessment of these items

5. Dig into the tough areas and ask the hard questions, even if you may not like the answers; focus on what matters to the investment, not on ticking boxes

6. Triangulate information and validate findings from multiple sources; ensure that different sources and stakeholders are telling the same story

7. Re-evaluate new information and findings throughout the process; ask "how does this change our investment thesis?"

8. Document all findings in a centralized location for easy future reference; use this to create a clear investment decision making document

9. Focus on integration and value creation; create a post-closing operational plan with clear action items, priorities and timelines

10. Utilize due diligence experts; engage an experienced advisor to help you navigate the due diligence process

In conclusion, it is crucial to have a well defined due diligence process in order to successfully invest in or acquire private companies.

At M-Squared Advisory, we view every client project through the eyes of an investor, drawing on past transaction experience. We have the expertise to help clients define and execute comprehensive and efficient due diligence processes.

If you are thinking about investing in private companies or need help with due diligence, we can help. Reach out here.