Commercial Due Diligence in Private Equity

Private equity investing has grown significantly in the last twenty years, as have the consulting practices that serve private equity. When Stax started working with PE funds in 1997, there were about four to five leveraged buyouts closed per week in the US. According to Pitchbook, that average today is more like 20 LBOs, and another ten or so private equity transactions of other types per week. At a median LBO deal size of $100M+, the pace of private equity investment is strong, if down somewhat from its recent peak.

Private equity has matured with strong historical growth attracting significant capital and leading to greater efficiency and competition for deals. Consistent high returns are more difficult to achieve. Even so, fundraising has remained strong, with over $2.5T raised in US PE funds over the last ten years — from both new and traditional sources of capital. Consultants serving PE have thrived in this environment, particularly the strategy firms that address commercial due diligence and portfolio company profit growth.

In today’s environment, what is consulting worth? What is the value of commercial due diligence from a strategy consulting firm? Are consultants worth less or more to private equity investors than they were ten or fifteen years ago? Under what circumstances is consulting worth more, or worth less? At Stax, we can provide quantitative answers to such questions.

There are established frameworks for understanding the value of information. Investing is a probabilistic endeavor, and consulting information can be evaluated in this context. Using this approach, we can quantify the value of consulting information in private equity deals.

There are two primary ways for a strategy consultant to increase returns for investors:

1) Help the investor to make better investment decisions.

2) Improve portfolio company performance post-investment.

We look at the investment decision portion and specifically at the commercial due diligence offering. In commercial due diligence, consultants vet the market and competitive position of a target, the likelihood of achieving management projections for profitable growth and the risks and potential accelerators to that growth. Here we consider a simple investment scenario with a target company with $15M EBITDA, where we assume no multiple expansion, a set of simple assumptions around the structure of a deal with three potential outcomes and probabilities associated with each.