To invest or not to invest. That’s a million-dollar–or perhaps several million-dollar–question that private equity investors grapple with on a daily basis. Of course, there’s no way to know for sure whether a deal will sweeten or sour over time, but conducting due diligence can equip investors with the facts they need to make the most informed decision possible. How can financial due diligence software help furnish private equity investors with the financial insights they need to invest wisely?
Let’s discover how private equity investors can leverage technology to mitigate risks. Before diving in, it helps to get an overview of the risks at stake when making private equity investments.
Private equity (PE) firms collect capital from investors to purchase equity in privately held, often struggling, companies. Typically, these firms have management teams that work with the company to overhaul and grow their business functions for increased profitability over time. After about a decade of garnering growth, these firms sell their share, sometimes achieving an impressive return.
Napkin Finance highlights the process along with its risks and rewards, saying, “Private equity funds pool money from many investors—whether people or institutions—then buy ownership stakes in a number of private companies in the hopes of later selling those ownership stakes for a profit. It’s generally a higher risk, higher return investment option.”
Private equity investors operate with the knowledge that the stakes are high. A failure could mean not just a personal loss but losses for investors and untold losses for those employed by a failed company.
Some of the most significant risks of private equity investments are:
- The time factor. – Private equity investments involve tying up large sums of money for an extended period of time. It may take a decade or more for a deal to pay off, that is, if it pays off at all.
- The investment required. – “A significant capital outlay is needed because private equity invests directly—often to gain influence or control over a company’s operations—so deep-pocket funds dominate the industry,” explains Investopedia. “As private equity investments require millions of dollars, they are usually not available to the average investor.”
- The uncertainty of success. – Often, the ROI of a PE investment hinges on a firm’s ability to recharge a dying company. Private equity firms must be confident in their ability to overhaul a business and turn a profit before fronting the capital.
- The uncontrollable factors. – As with any investment, PE investments are susceptible to unforeseeable factors, from global drivers like geopolitical and economic shifts to more localized risks like messy personnel and public relations issues or non-compliance.
Given the considerable risks of a PE investment, investors should be cautious when entering into a deal. First, they must do their due diligence. How?
Strategies for Mitigating Private Equity Investments Through Comprehensive Due Diligence
The top strategy for mitigating risk on PE investments is taking time to conduct financial due diligence, AKA gathering all the facts. What do private equity investors need to know before sealing a deal?
“When PE firms consider investing in a company, they need to make sure the investment is worthwhile. This is called the due diligence process, which involves investigating and verifying detailed information about the target company,” explains The Business Builders. “The process includes looking at legal, tax, financial, compliance, and technical aspects of the potential transaction to determine if it would be a profitable investment. This can be a complex process, but it is important to ensure that the investment is sound.”
Before investing in a company, PE investors should obtain and analyze the following information:
- Business information and reputation – Answer the following questions:
- Who are the business owners, and what are their shares?
- Who are the company’s executives, and what are their roles?
- What products and services does the company offer?
- Who are the existing customers?
- What is the company’s current PR status?
- What is the current operational capacity?
- Business assets and liabilities – When considering assets and liabilities, don’t forget the following:
- Investments
- Technology and IP
- Employee talent pool
- Property and real estate
- Mortgages, loans, leases, and rentals
- Tax liabilities
- Other assets (vehicles, inventory, intellectual property, trademarks, etc.)
- Financial statements – Collect and review relevant financial documents from the last five years, including:
- Income statements
- Cash flow statements
- Balance sheets
- Accounts payable and receivable
- Tax returns and tax documentation
- Statements from third-party auditing firms
- Credit reports (i.e., Duff and Phelps, Dun and Bradstreet)
- Fixed and variable expenses
- Insurance contracts and coverage
- Debts and liabilities, including outstanding loans and credit facilities
- Securities filings
- Payroll, including income information and employee benefits
- Forecasts, plans, and analytical data – Collect or create the following:
- Working capital assessments
- Financial forecasts
- Business plan (current vs. proposed)
- Compliance documents – Review all industry-specific regulatory compliance documents.
As long as it is, the above list is by no means exhaustive. How can PE firms collect, store, and share the above data between all relevant parties to a deal? That’s where financial due diligence software comes in.
How Private Equity Investors Can Leverage Financial Due Diligence Software to Mitigate Risks
Financial due diligence software is a must-have heavyweight in your corner when it comes to mitigating PE investment risks. How does it work?
Simply put, financial due diligence software helps you centralize all financial data into one secure data room, allowing you to tick all the boxes on your internal due diligence checklist before sealing a deal. Virtual data rooms (VDRs) can also facilitate regulatory compliance, helping investors avoid the legal, financial, and even criminal penalties associated with non-compliance.
Using a data room also facilitates secure collaboration when working with sensitive information often reviewed during the PE investment process, such as financial statements, employee data, and payroll. Admins and document owners can manage access to virtual data rooms and even individual documents to ensure sensitive information does not fall into the wrong hands. Virtual data rooms offer security that can’t be achieved using popular online file-sharing platforms, which are susceptible to hacking and don’t offer the same level of file permissions control.
VDRs promote transparency in a deal. Maintaining a centralized virtual space for document storage, viewing, and editing helps all parties stay on the same page and communicate effectively throughout the process for both PE deals and M&A transactions. “In a VDR, all actions by both parties are recorded electronically, unlike the manual work done in a PDR [physical data room], and can be tracked, verified, proven, and referred to at any time, thus ensuring the transparency of the process,” says the Institute of Mergers, Acquisitions & Alliances. “Moreover, increased transparency sets new standards previously unthinkable for physically performed due diligence.”
Beyond simply mitigating risk, financial due diligence software can effectively help PE investors raise capital by streamlining workflows and giving potential investors a professional, secure interface to review financial information and jump on investment opportunities.
The right financial due diligence software can revolutionize your operations, leading to better-informed decisions and raising capital. Enter: CapLinked.
Robust Financial Due Diligence Software
CapLinked has engineered a comprehensive tool for conducting financial due diligence. Our virtual data room technology turns workflows like organizing data, communicating with stakeholders, and storing sensitive documents into a well-oiled machine.
Why choose CapLinked for your finance due diligence and investor data room?
Here are just a handful of features we can offer to add value to your PE investment process:
- Secure and searchable interface. – Centralize all financial documents into one organized database. Our data rooms support large file structures so that you can store your due diligence deep dive on each one of your ventures. Quickly find what you’re looking for with our robust search feature.
- User-friendly and easy-to-integrate platform. – Our attractive and intuitive data rooms are equipped with world-class security. Our system requires zero downloads or plugins, making it easy for all stakeholders and potential investors to navigate and interact with the interface while building trust and reducing frustration.
- Custom digital rights management. – Document owners can set custom user permissions to ensure the security of sensitive financial information. Our virtual data room enables you to track edits, manage permissions, and revoke access to files even after they have been downloaded. That way, you stay in control of your firm’s sensitive data.
- Real-time activity tracking. – Keep a pulse on all document views and edits, and get notifications when further action is required to keep the process moving and promote more efficient collaboration between all parties. Our VDR has a detailed activity feed that helps you stay alert to any changes.
- Professional and modernized workspace. – Add value to your operations and boost your reputation in the finance world as a cutting-edge firm. Our secure data rooms give you a smart platform for communicating and sharing files with banks, investors, and law firms.
Still, we don’t want you to just take our word for it. We want you to experience for yourself the elevated financial due diligence experience our secure virtual data room can offer. That’s why we offer a 14-day free trial. Get started today!
