Due Diligence for value creation

The number of private equity managers and the reported value of their asset under management have grown exponentially over the last two decades. In 2017, there were over 4,000 private equity firms globally versus just over a hundred in early 2000. The respective value of assets under management has grown to more than 3 trillions as opposed to c. US$600 billion during the same period.  This meant more and more managers and capital are competing for acquiring companies open to the participation of private capital, which usually comes with a mindset of creating value that ensures a profitable exit at the end of the fund’s life. This is known in the industry as active portfolio management or broadly speaking “value creation”. 

Almost all private equity practitioners agree that most of the value creation is realistically done through operational intervention and to a much lesser extent via financial engineering or multiple expansion. If and when all the three levers are carefully exploited and especially when coupled with favorable market condition, private equity managers are able to achieve superior returns for their investors. These returns averaged 400-500bps margin over the main indices and in the case of the top performers among general managers averaged 800-900bps spread. I can say with confidence that 85% of the these returns in any solid private equity business model is generated through introducing operational efficiencies. 

Value creation is not a slogan or a plan on paper. It is rather a way of doing business led by teams comprised of successful operational partners tasked with co-managing the business and ready to be parachuted to take on interim management roles when necessary. 

In addition to being a critical element of any sound M&A process, due diligence – or “know what you’re buying” - is a main pillar in any carefully crafted value creation plan thereby increasing the acquirer’s likelihood of long-term success. Due diligence findings will not only highlight areas for post deal quick wins in areas like sales and finance improvements in the short term, bridge the correlation between pre-merger and post-merger objectives, but also are used to outline the main pain points requiring attention from the operational intervention team. With accumulated experience over time, frequent acquirers learn to sense trouble spots and are aware of where their experience and key skills are sufficient and where are any skills/knowledge gaps that need to be addressed by onboarding outside operational partners.    

Unfortunately, it is the case that activities before and after the deal are often treated as isolated work streams and this creates the lack of consistency and results in a significantly suboptimal execution of this article’s central idea of not overlooking the opportunity to take advantage of the correlation between the due diligence and the following value creation journey. In summary, all findings in due diligence segments: commercial, operational, supply chain, IT as well as leadership and team should be used to help identify important steps that can increase the success factors for a positive post deal impact. There are essentially two approaches to achieving this sought-after correlation – by ensuring an overlap between people in the teams responsible for either task and secondly by making implementation a central part of the due diligence process. 

About the author:

Mustapha Boussaid has 20+ years in private equity and principal investments covering North America, MENA and Asian markets with focus on offshore oil & gas, maritime, construction and healthcare.