Platform acquisitions carry unique risks. Deals requiring larger investments are heavily scrutinized by third-party investors and lending partners. Due diligence is critical, and a comprehensive approach can help you avoid unnecessary seller fatigue and set your platform investment up for success.
These seven diligence areas will help you validate historical business data, find opportunities for value creation and scale, and identify issues, risks, and red flags in your proposed platform purchase.
1. Commercial due diligence
An important step for firms to perform early in the deal process is assessing your target’s place in the market. Commercial due diligence helps you understand both the internal readiness of a potential platform investment and the external forces shaping its market environment. Internally, it evaluates the strength of the target’s business model, sustainability of revenue streams, pricing power, sales capabilities, and organizational scalability and depth. Evaluating these areas highlights where competencies support growth and where weaknesses hinder execution.
Externally, it assesses customer dynamics, competitive positioning, market growth trends, regulatory shifts, and emerging threats to identify where genuine opportunities exist. Is there a significant growth opportunity within the target market that would help grow revenue? What are the growth projections for the investment? Or are there market headwinds you might encounter? Commercial due diligence helps to answer these questions.
By integrating these internal and external perspectives, commercial diligence validates the investment thesis and quantifies the gap between current capabilities and market potential. It also identifies the strategic levers required for success, such as organizational upgrades, sales force optimization, new growth markets, and product innovations. Without this dual lens, private equity firms risk underestimating capability constraints or overestimating market tailwinds, leading to missed growth targets and reduced exit multiples. Conducted early, it ensures go-to-market strategies are market-aligned and ready to be executed.
2. Financial due diligence
Validating the target’s operating results is critical to support the proposed purchase price and expected returns. Evaluating your target’s cost structure can help you maximize strategic alternatives and react effectively to changes in the macro environment. Assessments of fixed cost structures in selling, general, and administrative expenses, and attention to semifixed costs in platform gross margin profiles are particularly important.
Financial due diligence examines the exposure and upside to fixed cost structures by stress testing scalability, including a detailed data-driven analysis of historical EBITDA performance. This analysis identifies risks and opportunities in the platform’s cost structure (overinsurance or gaps, right-sized back-office functions, etc.) It also delivers true data points for fixed cost leverage and additional value creation post-close, highlighting opportunities for future add-ons throughout the investment life cycle.
Firms should also review their target for margin trends over time to understand how the business has performed historically while also identifying future opportunities for value creation, resource asset and optimization, and sustained growth. An evaluation of master data and costing accuracy helps to ensure your new portfolio company has accurate and timely performance data to improve decision-making, increase EBITDA, and explain changes in business performance.
3. Operational due diligence
Maximizing a platform investment requires a deep understanding of the operational backbone that drives business performance. Operational diligence focuses on evaluating the scalability, efficiency, and resilience of core operational people, processes, and systems. It also highlights risks, offering critical insight into potential capital investments required to maintain existing revenue streams or support future growth.
A thorough operational diligence and review can identify areas for optimization, assess capacity constraints, uncover hidden inefficiencies, validate strategic initiatives, and mitigate risks tied to underinvestment. Without this insight, private equity funds may face unexpected hurdles post-close, limiting their ability to achieve synergies, execute value creation plans and potentially impacting exit valuations. Early operational diligence enables the development of targeted improvement strategies and ensures that the platform is equipped to support accelerated growth and integration of add-ons.
4. Tax due diligence
Private equity fundraising is driven heavily by after-tax returns to investors, which in turn places special emphasis on tax considerations and sound structuring during tax due diligence. Tax liabilities and distributions can have a material impact on cash flow, and tax structuring can help reduce taxes and increase ROI upon exit. Additionally, it’s critical to identify tax exposures early and set plans to remedy pre- or post-closing to reduce the impact of the exposures on future valuations. Including knowledgeable tax experts early in the due diligence process and after closing can help ensure efficient tax positions that provide the necessary upside to the platform investment.
5. IT due diligence
Whether it’s ERP software selection or an assessment of potential CRM systems, the platform’s technology stack needs to support dynamic, real-time reporting and must have the flexibility to scale with future growth and add-on acquisitions. An IT diligence assessment will answer the question: Is the current system adequate for the growth trajectory of the business? IT diligence also provides private equity investors with a roadmap to get where the platform needs to go regarding system capabilities. This focused diligence can also highlight critical weaknesses, additional required investments, and financial and operational risks from system disruptions.
6. Cybersecurity due diligence
As cybersecurity events and risks become more pervasive, the potential threat to a platform’s organization is immeasurable. To understand and mitigate cybersecurity risks in a proposed platform acquisition, the cybersecurity diligence team needs to review current measures to safeguard sensitive data, check for vulnerabilities in the data security framework, assess risks, and identify any areas for remediation. A cybersecurity breach can lead to critical financial and operational impacts and ruin brand value and other commercial relationships.
7. HR due diligence
The success of platform acquisitions often depends on the team that will execute the vision of future growth and performance. Two of the most overlooked risks are talent gaps (the human capital needed to take an owner-operated business to a sponsor-backed platform) and the alignment of rewards programs necessary to retain and incentivize key team members. Human resources due diligence should also include a review of organizational structure, culture, HR processes, payroll, benefit plan administration and compliance, and regulatory risk to ensure seamless integrations of add-on opportunities.
Mitigate risk with comprehensive due diligence
With high demand for quality platform investments, record levels of capital available, and narrowing time windows to get it invested, the pressure to get deals done has increased. Platform acquisitions are high-risk if not properly assessed upfront via efforts across multiple diligence workstreams. Due diligence is the time to mitigate risk, and a comprehensive approach can help secure investments that are primed for success and growth.
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