Integrated Due Diligence: The Big Picture

The private equity industry may have plenty of positive momentum, but margins are backsliding, and not just by a few basis points.

On average, our clients underwrite almost 300 basis points of margin expansion during their holding period. Over the last decade, though, what they've actually gotten is margin contraction of 100 basis points.

When we first saw this trend emerging in our deal-flow data, we wondered, “Is this just a 50/50 issue, where maybe half the time the industry misses its targets, but the other half it’s on point? Or is this a pervasive, structural problem?”

We found that 75% of the time—that means three deals out of four—our clients were making the wrong calls. So it would seem the industry better sober up and lower its margin forecasts, fast.

My colleague Rebecca Burack, who leads Bain’s Private Equity practice in the Americas, can practically hear your objections to that idea.

“But Hugh, if they wrote that into their deal model, our clients would never, ever win a deal,” she told me in the latest episode of Dry Powder. “They need to count on this margin expansion. They need to believe it. They need to convince their colleagues and lenders. And honestly, what they need is a holistic appraisal of the company's full potential—one that acknowledges all of the critical interdependencies and pinpoints the exact levers and, frankly, the timeline on which they can pull them.”

So how do you deliver on the margins you promised, starting day one, Monday morning, 8 a.m. on the dot?

Rebecca says it comes down to a simple but neglected matter of microeconomics. The leading PE firms have dusted off a classic approach: seeing all of the moving parts of the deal—cost, revenue, price or market share—play out over time, before they get the keys to the door. It’s called integrated due diligence.

I invited Rebecca on the show to discuss, first, why the margin equation keeps breaking down and, second, how it might be fixed by taking an integrated approach to due diligence.

MORE PODCASTS

The Private Equity Podcast

In our podcast series, Bain's Hugh MacArthur interviews leading experts on the trends and opportunities that will redefine the private equity industry.

In part two of our series on integrated due diligence, Burack returns to talk about the cutting-edge tools that help PE firms quickly see all the parts of a deal in a single, moving picture.

Catch new episodes by subscribing to Dry Powder on Apple Podcasts, Google Podcasts, Spotify or wherever you may listen.