PE-style Due Diligence in PC
Would greatly appreciate if someone could provide some color on what work an associate might do during a deeper private credit due diligence process. Besides typical modeling and going through what’s provided in the data room, what sort of primary / 3rd party research is conducted? Thanks
Based on the most helpful WSO content, during a deeper private credit due diligence process, an associate's role extends beyond typical modeling and reviewing materials in the data room. Here are some key activities an associate might engage in, focusing on primary and third-party research:
Third-Party Reports Analysis: Associates often analyze reports from third parties that cover various aspects of the target company or asset. This could include seismic reports, Phase I environmental assessments, zoning compliance, and insurance coverage evaluations. Each of these reports provides critical insights into potential risks and liabilities that could affect the creditworthiness of the deal.
Legal Documentation Review: Working closely with legal advisors, associates review and interpret legal documents related to the deal. This includes going through construction contracts, lease agreements, and any litigation history. Understanding the legal framework and any potential legal hurdles is crucial for assessing the viability of a credit investment.
Industry and Market Research: Conducting in-depth industry studies and market research is another key area. This involves gathering data on market trends, competitive landscape, regulatory environment, and potential market disruptions. Associates might use a combination of in-house research and third-party industry reports to build a comprehensive view of the market in which the target operates.
Management and Operational Due Diligence: Associates often participate in evaluating the management team and operational capabilities of the target company. This could involve background checks on key management personnel, reviewing the company's IT systems for efficiency and security, and assessing the company's operational resilience and scalability.
Financial Analysis Beyond the Model: Beyond financial modeling, associates dig into the financial health of the company through detailed analysis of its financial statements, tax obligations, and cash flow stability. They might also assess the company's capital structure and its implications for the private credit deal.
Site Visits and Onsite Evaluations: When possible, associates may participate in onsite visits to the company or asset in question. This hands-on approach allows for a better understanding of the operational realities and can uncover insights not visible through documents alone.
Engagement with Industry Experts: Associates might also engage with industry experts to gain deeper insights into specific areas of interest or concern. This could involve discussions with consultants who specialize in the target company's industry or technical experts who can provide detailed analysis of specific operational aspects.
Each of these activities contributes to building a comprehensive understanding of the potential investment, enabling informed decision-making in the private credit due diligence process.
Sources: Advice for New Analysts Seeking PE Exits, https://www.wallstreetoasis.com/forum/investment-banking/breaking-into-private-equity-from-banking?customgpt=1, RE Debt | Managing the due diligence process, Breaking into Private Equity from Banking, HF to PE post-MBA - my story and seeking advice (long-time poster)!
Based on the most helpful WSO content, during a deeper private credit due diligence process, an associate's role extends beyond typical modeling and reviewing materials in the data room. Here are some key activities an associate might engage in, focusing on primary and third-party research:
Third-Party Reports Analysis: Associates often analyze reports from third parties such as seismic, Phase I environmental assessments, and zoning reports. This involves understanding the implications of these reports on the creditworthiness and operational risks of the borrower.
Legal Documentation Review: Working closely with legal teams to review and understand all legal documentation related to the deal is crucial. This includes going through construction contracts, lease agreements, and insurance policies to identify any potential legal risks or issues.
Industry Study: Conducting or reviewing an industry study is another important aspect. This involves analyzing the market dynamics, competitive landscape, and regulatory environment of the industry in which the borrower operates to assess its impact on the borrower's future performance.
Management Background Checks: Performing background checks on key members of the borrower's management team to ensure there are no red flags that could pose a risk to the investment.
Financial Analysis Beyond the Data Room: While the data room provides a starting point, associates often conduct their own financial analysis, which may include building out detailed financial models, stress testing financial projections, and analyzing the borrower's historical financial performance in detail.
Site Visits and Operational Reviews: Depending on the nature of the borrower's business, associates might participate in site visits to conduct operational reviews. This could involve assessing the condition and efficiency of the borrower's facilities, understanding the operational processes, and evaluating the management team's effectiveness.
Insurance and Risk Management Review: Reviewing the borrower's insurance coverage to ensure it is adequate and identifying any potential risk management issues.
Vendor and Customer Interviews: Conducting interviews with the borrower's key vendors and customers can provide valuable insights into the borrower's business operations, reputation, and market position.
These activities are part of a comprehensive due diligence process aimed at uncovering all potential risks and validating the investment thesis. It's a meticulous process that requires a deep dive into various aspects of the borrower's business, legal standing, and market environment.
Sources: RE Debt | Managing the due diligence process, https://www.wallstreetoasis.com/forum/investment-banking/breaking-into-private-equity-from-banking?customgpt=1, Advice for New Analysts Seeking PE Exits, Breaking into Private Equity from Banking, HF to PE post-MBA - my story and seeking advice (long-time poster)!
Bump
We usually conduct 8-12 expert calls which are mostly confirmatory in nature. On top of buyside DD of course
8-12 seems extremely overkill. At my shop we do 2-4 for most sponsor backed deals and 6-8 for hairier deals. What do you gain from doing 10+?
We are probably one of the more cautious debt funds. We usually want to speak with at least 2-3 customers, competitors and former employees. You quite often hear experts say the exact opposite from each other so 1-2 per perspective might not be enough.
What does buyside DD entail?
Usually own CDD, really depends on asset size, complexity and sponsor. Just yesterday received 100 page Buyside CDD, but also had BCDDs with only 35 pages. Sellside CDD usually grossly overstates market, differentiating factors, strengths, downplays competition etc
is this for DL deals? My DL friends are fighting to give out capital - they can't do this level of underwrite and hope to close within sponsor's timeline.
How do you source and vet those experts? And how do you contract them/pay them by the minute? I have heard of platforms but not sure what the seniors are doing.
Due diligence calls with customers, competitors, consultants in the space. Third party market study reports to validate competitive landscape, differentiation, market share, avenues of growth either through current strategies or new strategies. Financial due diligence of course (Quality of Earnings reports from a public accounting firm). Tech due diligence if the primary product is software (how does it compare against their competitors, is it bleeding edge, etc). Other misc stuff like environmental studies and legal due diligence to make sure the company isn’t going to get sued or have had legal issues in the past.
I think it starts with the extent of questions being asked by a fund alongside their 3rd party due diligence streams. There's a peel the onion mentality in the industry where some people just need to peel a couple layers, where others need to peel all the layers. Those that peel all the layers are doing fulsome due diligence, similar to the processes on the equity side for someone purchasing a business.
On the 3rd party side, it includes doing your own QoE work w/ cash proofs, expense proofs, rev recognition roll, extensive background checks on key people involved in the deal, market research, commercial diligence, environmental diligence, tech / IT diligence, specialized legal diligence (i.e. having a A&D contract lawyer reviewing specific contracts for key issues), insurance diligence, a multitude of expert calls - then taking what they learned on the expert calls and asking us to confirm/deny/explain what the expert might have meant by this, 2-5 management meetings, interviewing key bodies in the business, interviewing key customers and suppliers (through management introductions), etc. etc.
Would any direct lender doing a sponsor backed deal actually do this level of diligence?
Del
Typically not. You see much heavier diligence in the non-sponsored markets. The sponsor will typically try to prevent people from doing this level of work, but in the non-sponsored world that's where you can get really deep. I'm on the sell side at the moment, but if I was ever to switch over to the buy side it would be to do non-sponsored lending as that is where the real work is done in my opinion
Non-sponsored is in interesting situations, rescues/DIPs or large cap plays. Pain in the @ss in LMM space, half the job is reconciling financials and hand holding shitty operators but that where the alpha is created however difficult to scale AUM.
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