GPs: Valuation top concern during diligence

Understated expenses ranked as GPs’ top concern in accurately valuing a target, a Deloitte report said.

The inaccurate valuation of a target and the failure to integrate a company are the two biggest concerns when pursuing a private equity transaction, according to an M&A report from Deloitte.

In the survey of more than 300 private equity executives, roughly 55 percent indicated getting the valuation right and the inability to integrate were the top two areas of critical concern.

Inaccurate valuations can hurt in both ways says Roland Dennert, a managing partner at the direct secondaries firm Cipio Partners, who agreed with the survey results.

“Overvaluation leads to inferior investment return to what the outcome could have been otherwise, while undervaluation leads to losing fine deals to competition,” Dennert said.

Dennert added that a lot of due diligence is required to understand all the relevant aspects of the company in order to get the valuation right.

Understated expenses ranked as a top concern in accurately valuing a target by 31 percent of the respondents, followed by understated capital needs at 30 percent and overstated revenue forecasts at 29 percent.

A potential portfolio company may understate expenses by delaying the recording of costs of goods sold or failing to record certain accrued expenses, while overstated revenue forecasts can occur when a firm boosts unobserved revenue.

The report also noted that when it came to some of the factors that lead to a successful deal, 37 percent of respondents cited economic forces as a main concern—with respondents placing a high importance on planning and forecasting.

This could also explain why the majority of private equity firms are trying to become more industry-focused, according to the report. “A correct understanding of the market and the growth dynamics of that industry, are the primary challenges when you are trying to put together a successful deal,” according to Per Nordlander, a partner at the Nordic-based secondaries firm Verdane Capital.

Apart from economic conditions, private equity respondents cited other issues that could help ensure a successful deal including privacy and security concerns and increasing interest rates.