With LBO activity still at a torrid pace, the ability to move quickly has changed from a “nice to have” quality to an absolute necessity. If one private equity firm says no to an acquisition, there’s usually two or three others waiting in the wings. And unlike previous buying frenzies, this time buyout shops aren’t just competing with each other anymore, as strategics and hedge funds are making the buying process more competitive and, in many cases, more expensive. Meantime, buyout firms are readying companies to go public, fund raising and managing their existing portfolios.
Given the tremendous time demands on buyout pros, it’s not surprising to hear market players say they’re concerned about issues like due diligence, which is happening much faster than normal and, in some cases, has been de-emphasized. “It’s interesting. On one hand you have the scandals that have been in the news, so you would expect firms to be a lot more robust in their analysis of companies, but, on the other hand, due to the market dynamics there’s so much cash sitting on the sidelines, the market is now in the seller’s favor,” said Avery Tuchman, a transaction services director with PricewaterhouseCoopers’ Private Company Services practice. “Everyone’s in a real rush to get the deal done.”
How rushed are they? Market pros told Buyouts that while the average due diligence process took six weeks a couple years ago, today that average has been cut in half, to three weeks. Another statistic to consider is the period from letter of intent to deal close. Hiter Harris, a co-founder of Harris Williams, says that it used to take anywhere from 45 to 60 days to go from letter of intent to deal close. In the current market, he has seen that happen in as quick as two to three weeks in extreme cases, however he notes that most of the time it now takes 30 to 45 days.
However, Harris says speeding things up isn’t necessarily a bad thing. “Buyers need to show sellers they are competent and can close the deal quickly. By making the process faster it will let a seller know if a buyer isn’t going to do what they say and can and go to another buyer,” says Harris. “Sellers need to be certain you can finish the deal. However, it’s important to note that even though the process has been sped up the quality of due diligence is still good.”
John Baumer, a partner with Leonard Green & Partners LP, isn’t sounding alarm bells either, but stresses that time is important when evaluating companies. “I’m a big believer that the best due diligence is time,” he said. “The way you learn the most about a company is by watching it and observing the how management interacts with each other and their employees. Time allows you to learn things that a balance sheet is incapable of showing you. Unfortunately in today’s auction environment, you don’t get that benefit like you used to.”
One way that private equity firms are combating the time crunch is by hiring consultants to help with due diligence, something that LGP is now considering more seriously. “We typically wouldn’t hire Bain or McKinsey as consultants-and hiring consultants is not a part of our strategy-but that might be something we’ll have to think about as more and more deals end up going to auction,” Baumer said.
That’s clearly helped companies like Bain Consulting. “If you look at the last couple of years, there have been trends toward more structured, rapid auctions. Every deal is a competitive auction and there is a small time frame to get the deal done. Firms still need to do the diligence but they need to do it faster,” said Tom Holland, Director and Head of Bain Consulting’s Private Equity Practice.
Harris says he is seeing consultants pop up more frequently in deals, and in the best cases those consultants have strong ties with the private equity firm. “The private equity firms that do the best with consultants are the ones that have a consultant that they always work with deal after deal. It’s not efficient to hire a consultant you haven’t worked with before just in the nick of time to get a deal done. And the faster a private equity firm can get through due diligence the bigger competitive advantage it has,” he said.
Savvy Sellers
To be sure, it’s not just the rapid investment pace that makes due diligence more difficult to get done these days. With sellers becoming more sophisticated and market conditions tipping the scales in their favor, it’s the target company that is setting the tone during an acquisition. In some cases the seller will limit the private equity firm’s access to information that might have been available in years past.
“It’s a lot easier for a seller to limit what he shares with potential buyers when there are 10 people looking at his deal rather than two. With all the competition, the buyers don’t have the upper hand anymore. Sellers are are limiting access to information up front,” said Fentress Seagroves, a transaction services partner within PWC.
More and more sellers and buyers are asking for data rooms as a way to speed up the due diligence process. One such company, Merrill Corporation, which sets up data rooms for sellers, has seen tremendous growth in the last year. In 2004, the company put together 519 data rooms last year worldwide. This year, Merrill is already on track to do 2,000. Perhaps what’s even more telling is the sheer number of people using the technology. In 2004, Merrill had 13,000 people using their data rooms. This year more than 62,000 people have already used one of their data rooms.
Data rooms allow buyers to look at documents from wherever they are and they can grant as much or a little access to potential buyers as the seller wants. They can also see how long a potential buyer has spent looking at each page, which can indicate that the buyer is possibly hung up on a particular issue. Data rooms also allows sellers to see how long a potential buyer spends looking at the information, which can be a telltale sign of how interested a buyer truly is.
“There’s a few reasons data rooms are becoming so popular. First of all, it’s a lifestyle thing. Buyers want to see their kid’s little league games and not be on a plane to Texas. The data room lets you view company documents from anywhere,” said Brian Gilbreath, a regional director with Merrill Corporation. “On the sellers’ side if you have 10 bidders, you have to run everyone though a paper room and each bidder takes six days. That’s 60 days to get through the process. In the virtual room you can give each potential buyer 12 days because every potential buyer can be in the data room at the same time.” Bankers like Harris certainly like the functionality. “This moves the process along so much faster and you can forward the information to potential buyers earlier and bar any information they shouldn’t see,” he says.
While data rooms will continue to crop up, there are also other ways private equity firms can make sound decisions about a company in a shortened amount of time. PwC’s Tuchman urges buyers to focus on the quality of management and the information given, even if only a nominal amount of information is given. “See how the CEO controls the company, how they operate, their readiness to make decisions, their relationships with one another. Observing, even if it’s for a short time, can tell a lot about a company,” he said.
One private equity pro agrees. “All the things that have been set up to make due diligence easier are great, even the consultants can be helpful, but nothing really replaces how you mesh with the company and how you feel about them and how they feel about you,” he said. “You need to have that face time, even if it’s for just a short time.”
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