Digitizing the due diligence process in private equity will lead to value creation faster

This story originally appeared in Middle Market Growth’s Summer Issue. All Rights Reserved.

Modernization challenges every industry. Longstanding practices often linger for a reason, and their depth of use within any company can make them tough habits to break.

This is especially true when the stakes are as high as they can be in the due diligence process in private equity.

But for PE firms to gain an edge in the market, their due diligence process needs a digital upgrade—and a shift from risk mitigation toward identification of value-creation opportunities.

Even though automating financial models is a relatively cost-effective and straightforward endeavor, many PE firms continue to use the Excel spreadsheets they’ve been using for the past 25 years to build deal models and analyze data. This limits the inputs and lens through which PE firms evaluate investments versus expanding their aperture to take in new data sources.

West Monroe recently conducted a survey of 100 private equity leaders (half on the deal side and half on the operating side) on the state of due diligence today, along with their expectations—and predictions—for the future.

Respondents gave insights into how they view the evolution of due diligence in private equity over the next three years:

• 70% said they’ll use more data during the diligence process, and 68% said they’ll use more tech and tools, versus people.
• 66% said they are more likely to buy targets in the future that have completed sell-side diligence.
• 27% said that “recommendations aligned to the investment thesis” is the most valued part of diligence today, but 40% said it will be the most valued part in the future.

There may be some resistance to shift away from years of practices that have served private equity firms well. But the digital mindset can be engaged immediately by companies at any stage, creating instant value that can set them up for years to come.

Improving the diligence process

We get it—it’s easy to simply say a process needs to be modernized and more effective. But let’s dig into some concrete steps that, if adopted, can help PE firms overcome the challenges they face:

Use technology and data to establish new benchmarks

Employing data and technology can help funds skirt the disadvantages of completing diligence in tight timelines. It can also help teams catch red flags that are more difficult to see remotely, by facilitating a holistic view of a business’s risks and opportunities. With that benefit in mind, funds should develop technology capabilities that allow them to quickly evaluate the types of targets they usually consider—and do it in a way that is repeatable from deal to deal, whether that means adopting (or creating) new software or leveraging a partner’s tools and capabilities.

Adopt new skill sets and turn diligence into action

When deal teams are accustomed to looking at the same diligence variables for each target, they get in a groove and tend to run on autopilot. But in evolving from evaluating risk to uncovering opportunities, some deal teams may need to fine-tune their skill sets or acquire new ones. To help move the process along, deal teams might consider creating a risk-oriented diligence summary and an opportunity-focused diligence summary, and then seamlessly transfer them to the operating teams when the deal is closed. We found this “transfer” happens less than half the time right now, representing a huge area of opportunity to realize more value from diligence.