Private equity due diligence: how to conduct it properly

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A private equity deal is a complex undertaking that can take months to close. Your PE firm’s funds, resources, time, and reputation are all on the line, and it’s critical to make sound investment decisions.

The shifts that have happened in the private equity market in the last few years—and the strong recovery in the U.S. PE deals market starting in late 2020—have proliferated dry powder to an all-time high. In October 2021 there was $920 billion of dry powder in the U.S. alone. But more deals don’t mean better choices—it means that PE deal teams must work harder to find deals that will produce a return on investment.

Private equity deal sourcing is an invaluable part of building a strong deal flow pipeline and setting your firm up to close quality deals, but PE due diligence is the most important step to ensure the overall success of your firm.


Due diligence is how PE firms assess all the investment opportunities and determine which deals are worth pursuing, and which ones should be passed over. This is a large pool to evaluate; the average private equity investor reviews 80 opportunities for every one investment.

When your PE firm has sourced a potentially good investment, the deal team must conduct thorough but rapid due diligence. They’ll need to quickly assess the target company’s financial, legal, and management situation to minimize risks and identify opportunities within the investment.

In this guide to PE due diligence, you’ll learn what strong due diligence means to leading firms, how due diligence is unique in private equity, the areas your firm should be most concerned with during the PE due diligence process, and how to address those needs with the right private equity software.

What is private equity due diligence?

PE due diligence begins before a private equity firm enters a contract to invest in or buy a company. Done well, the due diligence process minimizes the risks and maximizes the value for the PE firm, LPs, and shareholders.

Due diligence is a normal part of the private equity investment process and will be conducted on any company (seller) the firm (buyer) is considering as an investment. In due diligence, the PE deal team gathers information about the target company, its history, and its assets to prepare an appropriate purchase price and a business plan for the company.

In addition to the PE firm’s standard due diligence, sometimes enhanced due diligence is required to uncover hidden risks and red flags, and keep the firm from owning a portfolio company involved in unethical or potentially illicit activities.

Due diligence is a critical exercise for improving fundraising success for GPs too. If due diligence can quickly eliminate poor-performing companies from consideration, the firm can focus its energy on better investments and improve the performance of the private equity funds it’s managing. And a track record of high-performing funds makes it easier to fundraise.

While this PE due diligence guide is focused on the due diligence a PE firm does to screen target companies, it should also be pointed out that companies seeking funding will often do due diligence on private equity firms as well.

What due diligence challenges are unique to private equity?

While the due diligence approach for a private equity deal is driven by the PE fund’s investment strategy, there will be nuances to assessing each target company, and each due diligence exercise uncovers unique challenges. Because the companies that fund managers are looking to invest in aren’t usually publicly listed, it can be harder to get all the information a deal team might need to feel confident in the deal.

Additionally, unlike venture capital investments that are often more strategic, many private equity transactions are purely financial in nature. In this instance, a PE deal team may focus more time on the financial aspects of the deal than the management or commercial aspects, and require much more data on the company’s financial situation.

PE due diligence is typically guided by the confidential information memorandum (CIM)—a massive document the company provides that includes financial data, an overview of the management team, and commercial details including insights around the customer base, products, and competitors. Smart PE firms don’t rely solely on the CIM, however, and they always check the information for accuracy.


Phases of private equity due diligence

Broadly speaking, PE due diligence happens in two phases: exploratory due diligence and confirmatory due diligence.

In the exploratory phase, the deal team is focused on assessing immediate fit against the fund’s investment thesis. They may also be looking for confirmation that the firm and its investors can make an impact on the commercial aspects and management of the company.

If the target company passes this initial screening, the PE deal team will move forward to the confirmatory due diligence phase. Here the deal team is spending more time and resources to ensure the information the target company provided is accurate and up to date. The firm validates its assumptions in this phase, and will often engage third parties (e.g., lawyers and consultants) in the due diligence process.

In confirmatory due diligence, the deal team digs deeper into the company’s financial and legal aspects, and will often look much closer at the management team.

Areas of due diligence

Every PE firm will have its way of conducting due diligence, and each target company requires a unique approach. But there are a few categories of information that almost every PE deal team needs:


Commercial due diligence evaluates the industry and the company’s position in the marketplace.

Because a PE firm’s investment goals are often financial instead of strategic, some firms don’t have the in-house knowledge that an industry expert would. Understanding the ins and outs of an industry to assess a target company’s financial viability takes time and energy—but it’s critical to estimating the company’s future potential.

Once your deal team understands the industry, you’ll have context for its commercial activity, i.e., how the company operates.

What to evaluate:

  • Industry dynamics and technology
  • Key industry ratios
  • Recent industry transactions
  • Industry growth trends
  • Market size
  • Competitive landscape
  • Company’s position against competitors
  • Customer base
  • Sales volume
  • Supplier base
  • Product/service pricing
  • How the company achieves value creation for its customer base
  • Product/service differentiators
  • The current business model, i.e., how the company sells its products and/or services
  • How prospective and current customers perceive the value of the product


In financial due diligence, your deal team will first be confirming the financial performance information that the target company has shared. After all, if the financials look too good to be true, they probably are. This is a deeper look into the financial information provided in the CIM—and a diligent deal team will look beyond the presented numbers as well. Comprehensive financial due diligence helps the firm determine the appropriate valuation for the target company.

What to evaluate:

  • Income statement
  • Cash flow statement
  • Balance sheet
  • Financial projections
  • Bank statements
  • Audits
  • Schedule of bad debt and/or write-offs
  • Accounts payable
  • Current accounting system
  • Leases
  • Inventory
  • Materials contracts
  • Product margins
  • Customer contracts and invoices
  • Customer acquisition cost
  • Customer lifetime value
  • Customer turnover rate
  • Intellectual property

The financial evaluation will also likely include a Quality of Earnings (Q of E) assessment. This is a rigorous report on how the company is growing, the biggest risk factors that may hinder that growth, and how likely it is the company will continue to grow into the future. It also looks at what the company can expect to earn on an ongoing basis. The Q of E process sometimes involves mathematical thought experiments, like what might happen if the company’s biggest customers canceled their contracts, or what might happen if the company’s biggest suppliers went out of business.


Before a private equity firm spends resources on legal due diligence, the deal team should be confident in their decision to move forward with the investment. In addition to confirming the assumptions made by the firm, verifying that the target company is not exposed to unforeseen liabilities, and validating that the company complies with all laws and regulations, legal due diligence also considers the legal consequences of the purchase.

What to evaluate:

  • Articles of incorporation
  • List of shareholders and percentages owned
  • Bylaws and amendments
  • Annual reports
  • Compliance with state and federal laws
  • Any legal claims against the company
  • Any known outstanding liabilities
  • Exclusive supply agreements or purchase agreements
  • Contracts with existing vendors, suppliers, and customers
  • Legal ramifications of a change in control at the target company
  • Open contracts with existing portfolio companies belonging to the PE firm

Note: Even though the purpose of a private equity investment is to help the company improve operations and generate more revenue, this process can stir up new legal issues. It’s important to have a trusted lawyer involved in the legal due diligence process to help the deal team spot any potential problems they may have missed.

Management and operations

A private equity investor is going to spend a lot of time with their portfolio companies’ management teams. Management and operations due diligence helps ensure that time is well spent. This stage is focused on how leadership is performing, how easy or difficult the management team will be to work with, and where there might be opportunities to improve operations.

Problems found in this arena aren’t necessarily make-or-break points in the deal. In fact, an underperforming management team or inefficiencies in operations can be easy places for a firm to add value quickly. Spotting these problems during due diligence might also help secure a better price on the purchase of the company.

What to evaluate:

  • The organizational structure of the target company
  • The management team, customers, and suppliers via interviews or meetings
  • The management team members via a background check
  • Identify unprofitable products
  • Identify products that could be much more profitable with a strategic infusion of resources
  • Identify new sales and marketing channels
  • What capital expenditure could be reduced with more efficient technology

Private equity investment should drive the improvement and growth of the target company and increase the company’s value before an exit. Thorough and thoughtful due diligence around the management team and day-to-day operations can make sure both your firm and the target company are set up to succeed together.


In the same way that your team has a full private equity tech stack, most companies are supported by technology and IT infrastructure, so the IT due diligence process should evaluate a company’s current technology capabilities, scalability, and degrees of risk.

What to evaluate:

  • Software and hardware used by the company
  • List of all software and hardware, including ERP, supply chain management applications, customer relationship management solutions, and financial and accounting systems
  • Analysis of current IT system and network infrastructure
  • Data management and data security practices
  • List of IT staff
  • Agreements with outside IT companies
  • Documentation of disaster recovery plan and cybersecurity policies and training programs


Improving due diligence with relationship intelligence

This guide to PE due diligence is not a comprehensive list. There is much more to the due diligence process than can be captured in a checklist. But this guide should give you a starting point for where to focus your deal team’s attention to reduce investment risks.

As you and your team go through the due diligence process, it can be helpful to be able to quickly identify the warmest path to an introduction and document your pre-diligence conversations with prospective companies in a centralized location. Affinity’s relationship intelligence CRM makes this simple by capturing relevant contact information automatically and providing insights that help your team track, manage, and close more deals faster. Talk to our team today to learn more.


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