HCL TECHNOLOGIES

Private Equity Due Diligence – Think

Operational Operational Due Diligence for PE firms

Ramkumar Rajachidambaram

4/30/2014

Operational due diligence is critical to identify the areas of improvement such as purchasing, supply chain and sales in order to buy a target company. HCL can support operating partners in conducting through due diligence and help them in making a correct buying/investment decision

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Private Equity Due Diligence – Think Operational

Introduction Due diligence of private equity and its portfolio companies is very critical in current

uncertain environment. The operational due diligence is critical to address new

regulatory regimes, anemic global economic growth, and the perpetual threat of

financial destabilization.

PE Partners are far more involved with portfolio companies and therefore able to

provide significant input. They employ experienced operating partners, or

individuals with deep functional experience and industry knowledge, to act as board

members and to consult with portfolio-company CEOs and senior managers

throughout the lifecycle of the investment. Seasoned PE operating partners support

the portfolio management teams streamline operations, concentrate on core

strategic aims, and deliver profits to the bottom line. Such activities include

influencing the CEO to spin out a nonessential division, restructuring a company’s

operational structure to keep processes lean, or providing cash management

expertise to portfolio companies acquired through leverage.

Operational Due Diligence Operational due diligence is focused on operational and internal data and aims to

find quick opportunities to improve performance. Operational due diligence is

hypothesis driven and vary on case to case basis. The areas where operational due

diligence is done are:

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Sales and Marketing Sales capabilities are the most crucial function and provide insights on the

company’s potential for rapid growth. Through management interviews ,operational

due diligence assess the firm’s efficiency in marketing, sales and account

management and its scope for rapid growth.PE firms often neglect the possibility of

profitable growth including pricing opportunities due to their less tangible impact

and mid-term focus.

Purchasing & Procurement Procurement is an important lever for supplier value creation particularly in aligning

purchasing across divisions and increasing transparency of external spending. HCL

conducts operational due diligence to classify spending according to categories,

suppliers, divisions and regions. Post classification a comparative analysis is done

across all the companies. Due diligence involves conducting stakeholder discussions

with purchasing executives and incumbent suppliers. Post discussion, a spend

analysis is done to identify areas for short term improvements.

Manufacturing and Supply Chain For this, operational due diligence involves conducting sample site audits and

external comparison to look for consolidation opportunities in the manufacturing

network. The analysis includes conducting shop floor assessments to identify poorly

aligned processes, underutilized assets with a scope to improve operations at

individual sites – leading to savings, increasing asset utilization, efficiency and

automation.

General Services and Administration This involves fully leveraging new technology and outsourcing opportunities.

Operation due diligences need to focus on areas such as Finance, HR, IT and sales

support to identify opportunities for co-coordinating processes, increasing systems

support and promote shared services, outsourcing and offshoring.

The due diligence should include stakeholder interviews with key managers,

resource analysis, quality survey and usage of external benchmarks.

Service Provider Assessments PE firms/its portfolio companies may outsource or use licensed technology

applications or their own proprietary software. In the case of outsourcing, due

attention should be paid to the importance of data being handled and whether the

outsourced company has proper backup systems in place. In the case of licenses,

investors should confirm that formal legal agreements are in place to use the

software for a given time period. Proprietary software has its own issues, including

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whether the software is maintained regularly, whether there is adequate IT support

internally for the software, and similar operational risk issues

Best Practice Approach HCL use systematic approach to assess the top line and bottom line

improvements,potential of a target company and its associated risks.The ideal time

taken to conduct operational due diligence should be between 6-8 weeks.The

challenge should be to obtain high quality data and perform high depth

analysis/assesments over the data.

The assesment should involve subject matter experts,access to industry

benchmarks to identify gaps and obtain comprehensive understanding of potential

for value creation.

Conclusion This paper has highlighted some of the major issues to consider when conducting

operational due diligence on PE firms. As is evident, the process is both complex

and time-consuming, but the outcome in the form of understanding operational risk

and associated challenges. Detailed operational due diligence would guide the PE

partners to assess if it has to invest its funds in the target company and the areas

of improvement that it wish to undertake post acquisition.