What is the due diligence you need to do in an LBO?

Startup Funding

Before a buyer can even talk to a seller, the buyer must examine their entire universe of deal opportunities and decide which they want to invest in the future; this process is called sourcing. The buyer is examining the landscape of companies and examining if they have the core traits they want in the business and weighing the investment
risk and benefits as well. The second step includes screening. The goal of screening is to reach a short-list of high-value opportunities and ultimately agree on a single target price to pursue that deal close.

Once the buyer chooses a company, the firm will sign a Non-Disclosure Agreement (NDA) with the company of their choice to access more confidential data. A signed NDA signals many rounds of due diligence lasting anywhere from a few weeks to a few months, and will review the seller’s confidential information memorandum (“CIM”). The due diligence process for an LBO deal typically involves questioning and confirming all key aspects of the business, especially the growth trajectory of the business and industry. PE firms will often hire 3rd parties to help out with different aspects of due diligence.

Some of the most important due diligence is done on the industry, and this can include competitor analysis, pricing analysis, volume analysis, and speaking with industry experts. Due diligence will also be done on the company’s financials, accounting statements, EBITDA and earnings, customers, products, strategy, distribution chain, etc.
There are many other common due diligence items that are more “check-the-box” and perfunctory in nature, which are often 100% outsourced to third parties. These include: IT, lender due diligence, facility due diligence, site visit, environmental due diligence, market sizing, compensation of management, ownership, legal, tax and insurance.