Due Diligence Tips For Private Equity Investors

For those who want to invest in or buy a privately held company, there are several important due diligence steps to take first. After assessing individual financial health and the ability to support the investment, these are some of the next steps to take.

Study The Company’s Business Model

One of the most important parts of an investigation is determining how the business makes money. Look at the company’s history of financial records. If something seems wrong, investigate it. For example, if a company’s projections do not seem realistic in comparison with historical financial records, ask questions. In a video from the University of Waterloo, an investor who had this experience said that the company simply expected to sell more during the following year. However, it offered no proof to support its projections. Stay away from such businesses.

Determine The Company’s Market And Top Competitors

Do some research to verify the size of the company’s market. Study the economic, demographic and regulatory issues that the industry faces, and look for trends that could indicate problems. If the company’s market is small and stagnant or large and diminishing, it is a risky investment. Also, look at the company’s top competitors. What sets it apart from the competitors? The company should have a unique value proposition that competitors do not offer.

Look at the pricing, market share, cost structure and growth rate of each top competitor. It also helps to look at consumer trends. Figure out why consumers pick certain competitors. Next, determine if those reasons will create a growing threat to the potential investment. If there are only a few competitors, think about how the emergence of more competitors may affect the company within the next several years. If possible, think about technologies or trends that may disrupt the industry and may affect the potential investment.

Investigate The Company’s Sales And Marketing

For a Private Equity Due Diligence operations, first determine how much money is spent each year on marketing, a tactic employed by CorporateResolutions.com. Divide that result by the number of the company’s new customers to see the cost of customer acquisition. Use other necessary calculations to determine the company’s expenditures and revenue, and compare the numbers to those of competitors. If they do not measure up, investigate further to find the problem.

While it is also important to look at customer satisfaction, it is even more important to look at customer retention. Find out how many customers come back to the business and why. Check with the Better Business Bureau and with other organizations to see if there are negative reports about the company. If there are consistent reports about the same issues across multiple channels, do some investigating within the company. Most complaints are tied to operational problems or poor business practices.

Look At Internal Risks

Two important areas to look at are insurance and human resources. Review the company’s hiring guidelines and employee structure. Are there opportunities for employee advancement? What is the turnover rate? Is turnover higher in certain departments? Figure out the problems behind any concerns in these areas to determine if they can be fixed. This is important even if the company only has a few employees. Hiring workers can be expensive, and the lost productivity that is associated with turnover is costly.

Look at the company’s insurance policies. Is it covered against all risks? Some companies have inadequate coverage to mitigate all risks, and an investor may have to spend more to remedy the problem. Find out if insurance to cover all liabilities is worth the investment in relation to other expenses and the company’s overall financial health.

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