Thought Leadership

Why private equity firms often overpay for acquisition

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After all the rigorous financial modeling that goes into due diligence, it can be hard to imagine how anything could have been overlooked. But when firms don’t look at the numbers within the context of a meaningful operational assessment, they often wind up overpaying for acquisition and targets.

A managing director at a private equity firm recently told us about a near misstep that still keeps her up at night. She was attending one of the final meetings with a target prior to acquiring the company when during a break, she happened to overhear a restroom conversation. It was two of the company’s operations people laughing about how the due diligence hadn’t looked beyond face value on some key financials. This led her to ask for a deeper operational assessment which uncovered that certain assets valued at nearly $250 million on paper were really worth closer to half that amount.

Discrepancies like this can come up for a variety of reasons. For instance, a manufacturer’s balance sheet could show sizable assets from steel inventory but only by walking the floor at each of their plants could you learn how much is truly active inventory. You may find that much of the raw material has been sitting for months gathering rust, making it virtually worthless without costly reprocessing.

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Or talking with the operators out on the floor might reveal underlying manufacturing issues that are building toward production delays in the near future. If production falls significantly behind schedule, there could be a precipitous rise in lost sales just around the corner. This could mean the AR showing on the books today may not be as valuable as it appears. Of course, evaluating the quality of earnings goes beyond inventory and AR, and everyone on the due diligence team is well aware of the need to pressure test all of the financial data. But with so many smart people all focused on preventing surprises, why do issues still often come to light after a deal is closed?

It’s not only the lack of time and bandwidth during the due diligence phase but also that people can grow comfortable with the returns they’re getting from their current way of working. When unforeseen operational challenges arise later or financial improvement is slower than expected, people tend to rationalize those setbacks. Often the finger gets pointed at the operating partner without ever tying the underperformance back to insufficient due diligence.

Spending too little time engaging with people at the point of execution can also lead some firms to pass up an acquisition that could have increased in value very quickly. Many of the operational issues that most impact revenue and costs boil down to a misalignment of people, process, and technology. These happen to be some of the issues that can be resolved the fastest when you have the right resources and expertise on your team.

What if you could consistently minimize your purchase price for acquisition while laying the foundation to increase valuation prior to divesting?

Our clients find that by supplementing their own evaluations with Proudfoot’s Pre-Acquisition Assessment, they experience a much higher average return over time. It gives you an objective basis for negotiating down the purchase price as well as reliable forecasts for revenue and cost enhancement based on real-world benchmarks.

We deploy with flexible scale and scope to match the context of the analysis you need with the information and access available. Our engagements can include one or all of the following:


Contact Michael Kirstein, Partner, PE Global at +447595 068 523 or to discuss supporting your due diligence team with Proudfoot’s world-class operational expertise and broad industry experience. Gain an edge evaluating your target’s current state and future potential, along with a roadmap for rapid operational improvement and value growth.

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Posted on February 21, 2020

By Proudfoot Team

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