Evolution of Quality of Earnings during uncertain times.

Evolution of Quality of Earnings

Quality of earnings is a foundational element of the pri­vate equity lifecycle, and as the oper­ating environment for PE becomes increasingly complex, it’s critical to get it right. At the same time, it’s become an intensely competitive space where a differentiated experience is key. Em­ploying a seamless experience – that takes a holistic view of a target’s strat­egy, operations, financial, tax and oth­er circumstances is essential to iden­tifying and understanding the opportunities for value creation. The growth and importance of technology diligence, for example, continues to es­calate.

The industry nuance that you need to bring has also become infinitely more important. The first question I get asked is if we have direct experience, or if we have worked within the industry before.

Historically, operational due dil­igence had a narrow remit on the quality of historical operations as opposed to being focused on value creation. At CLA we have moved towards a more expansive and cohesive approach that considers, for example, how you can best inte­grate components of digital, commer­cial, technology, HR and operational value creation together to come up with a plan that maximizes the poten­tial of the investment.

Seamless Experience

The capital structure of the deal is mission critical, and therefore the basis of the investment thesis around growth, operational value creation and cash needed to deliver transformation is a major focus of our clients. In an en­vironment where a lot of private equity firms are still pushing capital structures hard, and where multiples can get quite aggressive, the seamless experience gives the investment committee the comfort to take more aggressive decisions on debt levels and on the overall perfor­mance of the deal.

Due diligence origi­nally started in audit and today it continues to be seen by a lot of advisers as an audit checklist. In the past, private equity firms received that checklist in a report and then had to identify the risks and opportunities themselves. Now private equity firms demand more from their advisers, so at CLA we transitioned to an insight-led approach a while back to advise funds on how best to exploit the value opportunities and mitigate the risks.

Historically, financial diligence, tax, legal, operations, technology and cy­ber diligence all had separate volumes within a report, with very little integration between them. This resulted in not all deal opportu­nities and interdependencies surfacing. For example, if a technology opportu­nity had a significant operating model impact it may not have been fully cap­tured and understood in the other vol­umes of the report. As a result, we have moved at CLA to a fully seamless diligence product that successfully manages all the interdependencies, providing a uni­fied service.

Incorporate Strategy & Growth

Value creation includes a holistic review of cash, operations, commer­cial and digital, so the diligence prod­uct needs to coherently bring all those components of the thesis together with the phasing for delivery. There may be low-hanging fruit, such as purchasing for example, but then the timetable for

using digital as an enabler to improve business productivity can take two years to deliver and might also have a bigger cost component. You need to be aware of that time and cost. If you are considering these elements in iso­lation, you are likely missing the point.

How we can help

While the deal market is current­ly in the process of shifting from due diligence to value creation, our core diligence products continue to benefit our clients from having value creation at their heart. Our standard diligence offering today looks for both top- and bottom-line value opportunities.