By Elishama Mumo, Chief Client Relationship Officer
In corporate finance, due diligence has stood as the mainstay in identifying opportunities where capital can be put to work. Historically, private equity firms pioneered this practice, meticulously scrutinizing companies to identify profitable opportunities. Over time, due diligence has evolved, adapting to the changing landscape of investment practices. Today, it extends beyond the exclusive realm of private equity and plays a crucial role in the alternatives industry particularly within the domain of private credit. As technological advancements reshape the investment landscape, investors are starting to view due diligence through a different lens—one that considers not only financial metrics but also the impact of globalization and government intervention.
Decoding Due Diligence
Due diligence is the thorough investigation and analysis of a potential investment opportunity before committing any form of capital. It involves scrutinizing all aspects of the investment, including financial, legal, operational, and market factors. The element of counterparty risk is something that is rarely mentioned but is a key consideration for any capital allocator, and the due diligence process is a key driver for this. Any accredited investor whether individual or institutional is aware of the potential risk involved when one party in a financial transaction might default, fail, or not uphold their end of the agreement. The process has became a trademark of high finance so that one can mitigate risks, uncover hidden issues, and make informed decisions based on facts rather than assumptions.
Balancing Returns, Financialization, and Personal Values
The lines between financialization, value creation, and ethical responsibility has become increasingly striking. Investors today are increasingly recognizing the need to align their choices with positive societal impact while pursuing financial goals. And while they say this time it’s different, the practice still plays a pivotal role in assessing risks, understanding company fundamentals, evaluating management, and ensuring ethical alignment. With inherent values still being a guiding factor in investment strategies, investors can make informed decisions that balance returns with long-term sustainability and societal well-being. So why does it still matter?
One of the primary reasons due diligence is crucial for investors is risk mitigation. Conducting a comprehensive assessment of the investment opportunity on a micro level, can uncover red flags and assess the level of risk involved. Helping investors make informed decisions aligned with their risk tolerance and overall strategy.
Not all aspects of an investment are immediately visible. Due diligence allows investors to dig beneath the surface and uncover hidden issues.. Whether it’s undisclosed debts, legal disputes, or operational inefficiencies, investors make informed choices based on a complete picture of the investment opportunity.
Accurately valuing an investment is crucial for determining its potential returns. Due diligence plays a vital role in assessing the true value of an investment by analyzing its financial performance, market position, and growth prospects. Investors can avoid overpaying for an investment and ensure that they are getting a fair deal.
Investors who prioritize due diligence demonstrate professionalism and integrity in their investment approach. For portfolio and fund managers, it helps to build trust with stakeholders, and limited partners, and other market participants enhancing credibility in the market. This trust factor can open doors to future investment opportunities and solidify relationships with partners and clients.
A Changing Landscape
Some years ago, the world’s most renowned value investors, a duo that have captivated the investing world, Warren Buffet and the late Charlie Munger explained in their 2016 Annual Meeting as to why the practice has seemingly been abandoned as part of their day job of findings great companies. Warren highlighted that they have seemingly made plenty of mistakes in acquisitions, and made plenty of mistakes not making acquisitions, but their mistakes have always been about making an improper assessment of the economic conditions in the future industry of the company. But none of those would have been remedied by a lot more due diligence. They might have been addressed by a little more critical thinking.
What we see therefore, is now a deviation from financial, legal compliance, and operational risk assessment. Beyond financial statements, investors are now considering environmental, social, and governance (ESG) factors including sustainability practices, employee-well-being, supply chain ethics, and corporate culture. Valuations are no longer solely based on financial metrics. Investors increasingly evaluate intangible assets like brand reputation, innovation capacity, and stakeholder relationships.
Government intervention and market impact have also emerged as an impetus in shaping the entire process. For instance Tariffs and trade tensions between countries impact supply chains, production costs, and market access prompting companies with global operations to navigate these complexities. Government actions are restricting a company’s ability to expand or operate in certain regions, affecting revenue streams and profitability and Political instabilities witnessed in the past decade are continuing to become more frequent affecting exchange rates, impacting multinational companies’ profits and competitiveness.
Warren’s emphasis on critical thinking highlights the need to look beyond numbers. Due diligence should consider qualitative aspects, the influence of the macro-economic conditions and a bet on the industry’s future.
As the investment landscape evolves, due diligence may remain a strategic imperative for investors seeking to navigate complexity successfully but the methodology will evolve in light of the increased importance of ESG factors, the impact of government interventions, trade tensions, and political instabilities on globalization.
Elishama is Arielle’s Chief of Client Relations, A marketing professional with a background in business consulting and financial services. He endeavors to bridge the gap between marketing, finance and technology. As an avid music lover, he enjoys discovering musical gems and keeping tabs with global and macro-economic affairs.
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