
Management due diligence: Power to the people

The strength of a management team is roundly considered the single most important factor in determining the success of a private equity deal. So why is management due diligence the process to which most acquirers pay the least amount of attention? Susannah Birkwood finds out
Not even the smallest of fish in the PE pond would consider investing in a company without first checking its financials are in order. Conducting rigorous financial due diligence is vital for getting a deal off the starting blocks. However, carrying out systematic checks on a firm's human capital currently remains the preserve of only a few investors, which is surprising given that any fund manager worth his carry knows the management team is usually what makes or breaks an investment.
Of course, many large-cap firms would argue that unlike with financial due diligence, where if the condition of the entity is poor then you end up with a significant problem, if management turns out to be not fit for purpose, you can always change it. "One of the things that the bigger ticket private equity firms were always able to say was that they had access to the best quality management money could buy. So if it didn't like the existing team, it would just go and find 'best of breed' executives and sort out the issue that way," concurs ex-LDC CEO Michael Joseph, who is also chairman of Northedge Capital Partners.
However, even in the lower and mid-market arena, and where expansion deals are concerned, it is often the case that a GP won't meet with a management team until the point at which a transaction becomes a possibility – and by then they're expected to act fast. "A common attitude is just to check to make sure there's no deal-breakers among the team; it's more ‘I better make sure I'm not making a silly mistake' due diligence than looking objectively at the aims of the deal and finding out whether the management is aligned with them," Joseph says.
Another disincentive to doing more extensive checks during an auction process is the worry that the deal could be lost altogether. "Some people are reticent to upsetting the management by doing something that's slightly different," continues Joseph. "My reaction to that is most teams would like to be reassured that they were fit for the deal and if the process was sold properly, it wouldn't actually be a negative, it would be a positive."
LDC and 3i are among the big private equity names that have recently realised the merits of conducting more thorough pre-deal management checks. Another investor, ECI Partners, conducts these assessments as a matter of course, and worked alongside MDD advisers on each of the five investments they made in the past nine months. Sometimes all it takes is one bad experience to turn an investor into an management due diligence convert. "I once found myself bowled over by a management team that presented itself outstandingly and talked a very competent game, but when it came to it, they were in fact lacking in harmony with our investment strategy and goals," recalls Joseph. "We ended up having to make quite a lot of changes after the event, whereas if we'd done some more expensive investigations earlier, we might have been less persuaded by them and brought in a hands-in chairman to improve the situation. We might even have decided against doing the deal."
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