Seeing Through “the Sell”: Management Team Due Diligence in PE Investments

With the Fed’s recent rate cuts, a busy Q4 is upon us as deal activity picks up. At large, investors are bringing in human capital operating partners to deals more frequently, and earlier on in the process—something that helps get the big boxes checked, with a better understanding of what investors are buying before they sign on the dotted line.

The human capital due diligence process provides an opportunity to look beyond “the sell”—the deal-making relationship-building process during which target management team does everything to make a good impression—to better understand who they are as individuals, leaders, and strategic partners. Can they scale? Are they aligned with one another? Can they hold each other accountable? Do they have the capability to deliver?

While management assessments of any kind are beneficial, having them take place earlier in the process—ideally pre-close—is increasingly seen as an advantage, as it accelerates that time to value once the deal is done, and can contribute to de-risking the deal overall.

Management Team Assessments Shape Portco and Investor Success

Conducting management team assessments provides invaluable insights that significantly impact the deal process and post-close success. Regardless of when they’re conducted, these assessments focus on several key areas that drive important findings for investors. They examine the alignment among team members, the processes in place to achieve consensus on critical matters, the organizational capabilities, and the team’s collaborative dynamics, including established practices and methods for dividing responsibilities and maintaining accountability.

The assessment also provides a high-level impression of individual scalability, evaluating leaders’ adaptability, mindset toward continuous improvement, and their ability to embrace necessary personal and professional changes. Evidence supporting these abilities, such as past successes or struggles in letting go of responsibilities, is carefully considered.

The assessments also identify potential dealbreakers or areas of concern. For instance, while not an immediate disqualifier, a team member lacking prior private equity experience might be flagged as someone to keep on the radar, given the unique relationship investment and education required in PE environments. Conversely, for those with PE experience, their attitude towards it and any associated baggage are examined. Other red flags might include a lack of change capability, flexibility, or an abundance of skepticism. Ultimately, the assessments seek to identify management team members who demonstrate openness to input and view the investment as more than just a financial transaction, recognizing that this mindset is crucial for success in a private equity context.

While significant relationship building takes place during the deal-making process, management team leaders are still “on,” showing their best sides to support the momentum of the potential deal at hand. When a third party conducts an assessment, they’re able to provide an objective perspective on where strengths and weaknesses lie.

Driving Deal Clarity and Post-Acquisition Value Creation

Management assessments and benchmarks, when conducted thoroughly and with a clear methodology, offer a clear picture of what type of team investors are securing once the deal closes, whether that involves specific challenges or opportunities (or, as is often the case, a mix of both). This clarity accelerates the time to value post-close and aids investors in determining if the existing management team is truly backable or if changes will be necessary post-close. For instance, knowing in advance whether key positions like CEO, COO, or CFO need examination and potential replacement allows for more accurate pricing and budget allocation for future recruiting efforts.

These assessments, particularly when conducted by a third party, help pierce through the “sell mode” often displayed during deal-making, uncovering any red or yellow flags, gauging the team’s ability to execute the value creation plan (VCP) within the hold period. This information equips the deal team when finalizing their bid, preventing overpayment for potentially underperforming assets (or leaders, in this case).

From a cultural perspective, these insights also accelerate partnership advancement. They provide both parties with tools to hit the ground running in the crucial first 100 days, offering clarity on key priorities, management team strengths, and areas requiring attention. If management changes are necessary, identifying them early allows for swift action, minimizing disruption.

Advocates generally prefer pre-close assessments, noting that while they have rarely halted deals, they have provided valuable insights, ultimately saving investors from poor investments or waiting too long to make necessary changes post-close. In comparison, conducting these assessments post-close still has value, helping prevent a plateau or slowdown of momentum in the first 100 days. The greatest risk is delaying necessary changes, potentially leading to the realization a year into the hold that the wrong people are at the helm. Whether conducted pre or post close, a proactive approach not only mitigates risks but also positions the investment for optimal performance from the outset.

What happens when management team diligence isn’t done pre OR post-close?

• Investors spend the first six months of the hold period trying to understand the capabilities of the team, likely hitting walls along the way
• There is a delay in crystallizing the plan of attack and beginning to execute against key goals

Typically, when management assessments are conducted during month 6 or 8 post-close, it’s because of a substantial blocker or issue in either individual or full management team capabilities that are preventing VCP progress from being realized—and often, these would have been exposed in a standard pre or post close assessment process.

Doing Your Management Due Diligence

Management team assessments are a critical part of today’s PE deal process, providing insights that can prevent buying a “lemon” of a team and supporting faster results toward the VCP once the deal closes. By conducting these assessments, preferably early in the deal process, investors gain a clearer understanding of the team they’re potentially backing, uncovering strengths, weaknesses, and areas of concern that might otherwise remain hidden during the “sell mode” of deal-making. Strong data, benchmarking, and objectivity in the management assessment help ensure both investors and management teams are best positioned to take action, quickly.

As the private equity landscape continues to evolve, the role of management team assessments is likely to grow even more critical. By embracing these tools, investors can better navigate the complexities of deal-making, mitigate risks, and position their investments for optimal performance from day one. In an increasingly competitive market, this edge in understanding and preparing for the human capital aspects of a deal could make all the difference in achieving superior returns.