West Monroe Senior Partner Keith Campbell is a co-author of the report, The Future of Diligence in Private Equity, which highlights survey findings from 100 U.S. PE companies to explore the shifts in diligence approach that move away from identifying risk to identifying opportunity. That shift is happening in part because of unique market factors.
Campbell says 80 percent or more of diligence used to be on site pre-COVID. Post-COVID, it flipped, with the majority of diligence now happens virtually. For sellers, it's meant they're able to talk with more parties. Because of this, private equity clients are getting less access with management and need to use more outside data to accommodate that change in the diligence process.
With a lot of money still on the PE sidelines that needs to be put to work, along with a more competitive diligence process, valuations have gone up. That's helped bring a shift away from a risk-based, check-the-box diligence process to more emphasis on identifying sources of value and levers to pull to gain an edge and win the bid.
Traditional diligence reports essentially provide a red, yellow, green-type of assessment based largely on the company's risks and how to mitigate them. But little time is spent on outlining the opportunity.
"Knowing that the valuations have gone up and it's more competitive to buy companies, our clients, which are mostly private equity firms, are needing to come and deployed the value creation playbook and strategies to actually improve that base case so they can get the IRR that their funds are targeting," Campbell says. "And what that means is identify revenue growth opportunities that the company's not thinking about, and also optimize their cost structure — that's kind of the revenue cost tree that equates to EBITDA. And we're seeing just a big shift away from when we started doing diligence out of Arthur Andersen in the early 2000s, it was all about just, Hey, technology guys, don't kill this deal. Like, don't go find a large one-time investment or a cybersecurity risk. But now that conversation is switching away from risk to, how can we create value with digital and technology?"
Campbell spoke on the Smart Business Dealmakers Podcast about how much progress has been made toward these changes as well as what middle-market companies headed toward a process should expect from this new diligence approach.