Private Equity Deal Lifecycle: Due Diligence

Private equity due diligence is about assessing costs and value.

If the due diligence stage of the private equity deal lifecycle were described in a turn of phrase – it would be “measure twice, cut once.”

This critical stage involves collaboration between many highly skilled and specialized resources, including acquisitions, underwriting, legal, accounting, management, and technology experts representing both the target and the acquiring firm. The goal is determining the true value of the asset in play, as well as identifying what roadblocks may stand in the way of your firm realizing that value.

“‘Measure twice and cut once’ is about risk and money,” said Jeff Wilson, Founder and CEO of Saxony Partners. “It reminds me of another common phrase in private equity, which is ‘the money is made when you buy it.’ That phase refers to how much you paid for the asset – and the due diligence step is all about figuring out that number.”

So, how you figure out that number? You start by asking the right questions.

Question 1: Are there other cost factors in play?

The ultimate question that must be asked and answered during the due diligence phase is whether or not there are cost factors in addition to the sale price that need to be taken into consideration.

“Often, these costs are associated with staff and/or technology,” said Michael Martin, Vice President of Saxony’s Financial Services practice. “You want to know if they have the wrong CIO or talent team involved. You want to know if they’ve got legacy technology that needs to be upgraded, or if they have the wrong pieces of technology to support their strategy.”

“We’ve got the ability to come in and assess that stuff and really understand what the investment’s ultimate cost driver is to technology,” Wilson added. “That’s information that helps you make better investment decisions.”

Question 2: What are the technical debt and legacy implications of the company’s existing technology landscape?

Let’s double-click on the point that existing technology may be a cost factor that can negatively impact your ROI. Assessing the current technology ecosystem, particularly the costs associated with running the existing technology infrastructure, removes the element of surprise from the post-acquisition stage of the deal lifecycle.

These costs can include capacity, talent, infrastructure, development, applications, and more. If they are too high, or if the assessment indicates that too much money is devoted to propping up an ailing tech ecosystem, then you might need to rethink your investment strategy.

“If there’s a ton of legacy debt and the IT organization just runs in maintenance mode, then there’s not much value there,” Martin said. “The technical debt could potentially make it harder to sell the asset at a profit. Someone will come in and do proper due diligence at the next deal and discover that the legacy technical architecture is too expensive to maintain.

“We can understand a lot about an organization by looking at that cost structure. That really tells us whether or not this is a forward-thinking organization, one that values making investments for the long term that are going to pay off. And we can tell whether or not there’s a growth trajectory, which is going to have a big impact on the investment.”

Question 3: What’s your vision, and does it align with your roadmap?

Examining costs associated with existing technology is pretty straightforward. Assessing the interplay between IT and business vision requires a consulting team that has both industry and technology expertise.

A more nuanced way of asking the question above would be: What does the business want to accomplish – and how sturdy is the relationship between the business and its IT organization? On the latter point, does the IT organization see itself as a servant of fulfilling the business vision, or is it more of a cost center?

The quickest way to find out is to examine the company’s technology roadmap.

“We say ‘show us your roadmap and let’s see what investments you have on the radar, and how they fit the vision for your operational capability,’” Martin said. “One of two things tend to happen. Either you get a roadmap and it looks good – in that they have meaningful investments aligned to the business. Or, and this is surprisingly common, we discover that there is no roadmap. Or, if there is one, it’s not well thought through.”

Again, it helps to have a consulting partner that has both industry expertise and technology know-how to conduct these critical assessments.

“That’s why we get brought in by the leading private equity companies to help them think through these challenging issues,” Wilson said. “We’re different because a lot of us come from the industry and we view technology in its practical applications. Because we’ve actually lived with the technology solutions we’ve built over time, we have a different perspective on a potential investment’s existing tech landscape.”

A Technology Expert in the Room

As we mentioned in the introduction, due diligence is a massive effort that includes a collaboration of many highly skilled and specialized resources. When one walks into a due diligence session, they walk into a room of people all working together to answer very specific questions. Saxony Partners – with its proprietary blend of expertise ­– is well suited to answer questions associated with current and future technology costs and needs.

“If you rely on a legal team to answer legal questions, and you rely on an accountant to answer accounting questions, then you should rely on a firm like Saxony to answer technology questions,” Martin said. “If you don’t bring that level of expertise to the due diligence phase, you could find yourself at a disadvantage. And that’s when you lose money.”