Why You Must Do Your Private Equity Due Diligence

As the saying goes, “You must do due diligence!” You should never trust the numbers of a company when this company tries to sell you on its business. It’s true that you have their actual numbers, but you should also look at their projections as well. Here’s a story of why it matters.

Trickery through the Numbers

Back in 2012, Antonio Lopez wanted to buy a specific company, and it was a solid company with a stable EBITDA over the last 10 years. In addition, they had a solid cash flow. When Lopez looked at the projections in 2013, the EBITDA showed a triple in EBITDA. However, it had no big CapEx spend and no big acquisitions. The company tried to justify its price by convincing others that the projection of a triple EBITDA warranted the price. Luckily, Lopez didn’t buy this company and neither did smart investors. In 2013, they performed similarly to their 2012 EBITDA, which shows why you need to understand everything about a company when investing.

What to Understand

When you go to buy companies, you should first understand everything about the company in regards to its sales. For example, you should understand the customer concentration. For example, do half of the sales come from a single source? If the biggest customer accounts for three percent of sales, this could be a bad sign. As stated above, companies want to get investors to put money in with them, and if you don’t do your due diligence, you could be bamboozled by fake numbers.

Why You Should Always Do Private Equity Due Diligence

This process gets conducted as a way of protecting investors when making a big investment in a company. This prevents harm to both the seller and the buyer. You could perform this process in a variety of areas to better understand the business. Look at their financial statements, business practices and evaluate the management. You must understand every line on the income statement so that everything checks out. Double and even triple checking the numbers from the past can give you a lot of understanding of the company. You also should understand the industry because this will help you give your own forecast. The analysts and companies were wrong in many cases, which is why you have to learn how to think for yourself as an investor.

Read the 10-K’s and 10-Q’s

You can analyze the 10-K’s and the 10-Q’s to better understand the value of the company you’re investing in. It is imperative that you look at the company’s balance sheet and annual report before investing with them. However, you crunch the numbers and make sure that everything adds up. These will also be more comprehensive and cover every aspect of how the company to give you a better understanding of how the business performs. Smart investors will never overlook the proxy statement.

Having Someone Dig Deep for You

It’s true that you could do this research yourself, but the 10-K’s will often contain hundreds of pages. You have a lot of financial information that you need to understand, and if you don’t have the financial education, you will not understand what you’re reading. On the other hand, if you bring in financial experts to do the digging for you, you can get all this information to help you make a more informed decision on what companies to invest in. Corporate Resolutions, for example, offers private equity due diligence as a service. You can save yourself a lot of money over the long haul because you won’t make a big investment only to regret it later.

Private equity funds will often perform much better when the funds hire a third party consultant that conducts their due diligence.

Hiring a third party to do your due diligence can eliminate mistakes. Some of these companies live for doing this kind of research, and in fact, you will often hear them say that there’s nothing better than curling up with a 10-K and reading it during a long train ride. You might also do your own research but seek the assistance of an expert to confirm your theory to get even better results.