Financial, commercial, tax and legal data will undoubtedly come under scrutiny as part of a due diligence process. Behind the numbers and the spreadsheets lies the management team that will be responsible for bringing that perceived value to life. Without a talented and capable team fully aligned with the private equity (PE) backers, the investment thesis may be doomed from the outset. With a keen eye on the critical role of talent and the importance of cultural fit, houses are happy to bring external providers on board to add management due diligence (MDD) to the deal process. 

Views on when to introduce MDD can vary. Sensitivity issues often mean it comes later in the process. If there are concerns that senior management will feel their personality being questioned, it may be pushed towards the end of the process, once financial and legal hurdles have been cleared.

On the contrary, says Tom Everett-Heath, global head of investigations, diligence and compliance at Kroll: “My advice is do it early. You may well receive insights into the management team that can then inform how you negotiate, structure the deal, or think about what you will do post-acquisition.”

Time pressures can also play a part. “MDD should be essential, but we are using providers less because timing can be difficult. The period between exclusivity and closing can be too short to allow any real time for the management team to go through that diligence,” says Rich Pearce, partner at ECI Partners. “When we use external providers, it tends to be post-investment, in order to get a better understanding of the team. But the need for diligence can be a difficult message to deliver after you’ve invested.”

The choice of MDD provider tends to be governed by reliance on trusted sources rather than the need for sector or geographical expertise. In Everett-Heath’s view, the decision may also rest on the scope of work required. 

“Some PE firms see it as a process-driven exercise that they can use as a ‘go no-go’ input into their decision-making. Others see it more strategically and want a more expansive scope of work, providing the sort of questions they want us to address. It is driven by the importance they attach to the management team or how they view the capacity for taking on unforeseen risk,” he says.

While the specifics of each deal will obviously vary, there is a lot of common ground as to the areas to be looked at when assessing the management team. Much of this falls around talent, ambition, commitment to PE investors and the growth plan, and integrity (see box, Key considerations when assessing management). MDD providers will be asked to look at how well suited team members are to their roles, the team dynamic and how the CEO is viewed as a leader. There will also be an element of future-proofing, assessing gaps both now and as the business scales. 

There are two approaches to the research, explains Everett-Heath. “One is the harvesting, processing and analysis of information in the public domain, which can often raise questions that are not easily answerable. The second is human source intelligence, namely talking to people. Mostly that is done on a discreet basis, using our network to pose questions about our subjects. Being discreet rather than overt, you are more likely to get a truthful response.”

In some instances, more than one agency may be involved. Alongside the management report, WestBridge may use behavioural assessment tools, particularly when recruiting a chairman, chief financial officer or chief revenue officer (CRO). 

“It is a more psychology-driven look at the functioning of a team, and helps us to understand why someone may react in a certain way in a certain situation,” explains WestBridge investment director Rebecca Sinclair. “The whole board, including ourselves, will undertake the exercise and we will have feedback sessions as a group.”

Internal vs external

For PE firms, there is value to be had in starting the MDD process in-house to develop a relationship with and understanding of a management team before engaging an external provider. This helps in the process of building a relationship with the management team. It also means that a more concise brief can be given to the MDD provider. 

“We form a view on what we can achieve with a management team while developing the investment thesis. Alongside financials, market and growth opportunity, we look at whether we work with the management team to develop the growth strategy and understand how we can work with the team to develop them to achieve this,” says Sinclair. WestBridge will usually have the full investment committee meet the management team prior to exclusivity, “so that we understand how they tick – and to demonstrate to the management team our deliverability”. The information gathered can then help steer the brief for the due diligence process and give the investment team a greater understanding of the key questions to be answered. 

At Mobeus, emphasis is placed on 360-degree reviews with each team member, in order to map out an organisation’s structure and see where any gaps lie. The approach at this stage is more open dialogue and discovery rather than due diligence. “We don’t want to fully externalise the process, as crucially this is an opportunity to build a relationship with the team. When you start to map it together, you see areas of overlap or commonality and develop a textured picture of the overall team and where there are any misperceptions,” says Mobeus managing partner Ashley Broomberg. This then feeds into providing advisers with an informed scope and set of questions.

The management report may well flag up, or confirm, where gaps lie in the management team. How these gaps are filled can also be a sensitive issue. Founders and entrepreneurs can struggle to understand the impact that a CFO or CRO can have on the business, only seeing – and resenting – the expense. 

 “You can’t just impose a management structure on a founder. You have to go with them in partnership,” says Broomberg. At Mobeus, a lot of time is spent trying to find the right talent to work with the existing team, either through their existing network or, more often, using external search agencies. “That way, we are not always fishing in the same pond.” 

Independent view

Another tactic to overcome a tricky conversation is to involve a third party. “We have found it useful to get founders to speak to other portfolio management teams that have already been down this path. The message of the need for key personnel tends to come out much better from someone who has actually been there,” explains Sinclair.

The management team is the critical determinant of investment success. Understanding its strengths and weaknesses in order to provide the right support to succeed and not fail is a crucial, if complex, task. 

As Pearce concludes: “We have three investment pillars we assess on any investment: growth, resilience and a great management team. There’s a straightforward path to assessing the first two; assessing the third is more of an art than a science.” Investing time and effort into an MDD process can go a long way to helping in that interpretation.