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.
Craig Arends is a principal at CLA and is the managing principal of CLA's private equity practice. Craig brings a concentration of experience in providing accounting and transaction structuring advice for leveraged recapitalizations, purchase accounting and SEC reporting, assessing quality of earnings, and GAAP accounting. He has far-reaching experience with critiquing financial models and reviewing target companies' financial performance to identify cost reductions and/or operating efficiencies Craig has more than 30 years of experience in public accounting serving public companies, private equity groups, and companies, including a term as principal in charge of a Big Four Capital Markets Group in Moscow, Russia. He has led financial accounting due diligence projects for private equity investor groups and venture capital funds, primarily in the technology, communications, and manufacturing industries, as well as assisting with Foreign Corrupt Practice Act matters ranging from investigation of payments made, validation of compliance with corporate policies, and review of proposed transactions to ensure compliance. When not working, Craig enjoys watching any sports, but his most favorite are baseball, football and soccer.
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