DEEL2:
Further due diligence with management: The target company will begin providing more detailed confidential information in what is typically referred to as a virtual dataroom to the bidders that proceed beyond the first round. Some example dataroom files are the corporation’s organization and legal entities, board minutes and reports, detailed operations records, owned and leased property agreements, intellectual property documentation, employee lists and employment agreements, detailed segment financial information, and historical audited financials. At this point, private equity firms will begin reviewing all of the relevant dataroom files and start to get more specific, detailed questions to the management team. Follow-up due diligence calls will be held (through the supervision of the investment bankers) with specific members of the executive and non-executive management team. Also, based on the dataroom files, the deal team will start brainstorming the critical issues that they will often hire third-party consultants to help investigate.
Building an Internal Operating Model: After having detailed conversations with the management team on all of the main drivers behind the business, the investment team will start building a detailed operating model for the business based on reasonable forecast assumptions. An operating model is a very detailed revenue and cost breakdown that is based on specific drivers and assumptions (e.g. price, volume, raw material costs, number of branches, number of customers, renewal rates, fixed vs. variable cost structure, etc.). All of these breakdowns combine into one model to describe the expected financial performance of the company in great detail. This gives the PE investors more detail on the drivers of potential return for the acquisition.
Preliminary Investment Memorandum: Once the team has completed a more detailed investment model, and a comprehensive investment thesis (reason for investing) and strategy (plan to carry out the investment thesis), a Preliminary Investment Memorandum (PIM, typically 30-40 pages) is compiled to summarize the investment opportunity to the Investment Committee. Sections in the PIM typically include:
Executive Summary: Details of the proposed transaction, background, and overall deal team recommendation and investment thesis.
Company Overview: History, description, products & applications, customers, suppliers, competitors, organizational structure, management team biographies, etc.
Market and Industry Overview: Key market growth rates, trends, etc.
Financial Overview: Historical and projected income statement, balance sheet, and cash flow statement analysis.
Risks and Key Areas of Due Diligence: Potential risks to the industry/business and key areas of completed and ongoing due diligence.
Valuation Overview: Comparable company analysis, precedent M&A transactions analysis, DCF analysis, LBO analysis, etc.
Exit: Initial thoughts on investment exit options and anticipated timing of exit.
Recommendations and Proposed Project Plan: The deal team will recommend proceeding with their proposed project plan based on a specific valuation range and budget approved by the Investment Committee. The project plan will include the hiring of third-party consultants to perform commercial, financial, and legal due diligence, and the team will hold further discussions with potential debt and mezzanine financing providers. Deal teams will typically perform only initial legal due diligence at this stage, since it is the most costly, and will typically hold off on it as long as possible (usually until the final stages of the bidding process).
Final Due Diligence and process up to submit a binding bid: Provided that the PIM has been accepted by the PE firm’s Investment Committee, the investment deal team and its consultants will perform any and all final and confirmatory due diligence in order to provide a Final Binding Bid for the target company (discussed later). At this stage, the deal team is now working exclusively on this investment opportunity (other potential investments that the PE professionals on the deal team were working on will be put aside or farmed out to other PE professionals at the firm) and is having daily interactions with the seller’s investment bankers and management team. The bidder will send specific requests to the company based on all key outstanding issues. These could include site visit requests, calls with specific salespeople/non-executive management, or calls with customers and suppliers. In addition, the deal team will be managing its consultants on other due diligence work streams, including portions of the commercial, financial, and legal due diligence process (detailed in “Areas of Due Diligence”). For example, management consultants (McKinsey, Bain, BCG, etc.) are typically hired to perform commercial due diligence on the addressable market, trends, and customer relationships. Accountants (KPMG, PricewaterhouseCoopers, Ernst & Young, Deloitte, etc.), specifically within the Transaction Services group of the accounting firm, are hired to perform confirmatory financial due diligence to ensure that all the financial information provided is accurate. M&A lawyers (Wachtell Lipton Rosen & Katz, Skadden, Sullivan & Cromwell, Simpson Thacher, etc.) are hired to perform legal due diligence and to handle the initial drafting of acquisition documents. At the same time, the investment deal team will be negotiating with the financing banks on the debt financing terms. When negotiating, the deal team’s objective is to obtain the best debt financing execution (i.e. choosing the right group of banks) at the most favorable debt terms. The deal team will also assist the financing banks with their own due diligence by fielding their specific questions and concerns in order to get them more comfortable with underwriting their debt commitment. The average time for this entire confirmatory due diligence process (occurring between the First Round Bid and the Final Binding Bid) is approximately 3 to 6 weeks.