This is the second in a series exploring the differences in conducting due diligence for venture capital, private equity, and growth equity clients.
When private equity (PE) clients seek to make new investments, they need to conduct thorough due diligence to evaluate their prospects. The main concern for private equity firms when considering investing in a fintech company is if it displays the potential for success in a dynamic market. Private equity firms tend to be extremely analytical when choosing new investments, so it rare for them to forgo conducting due diligence as they risk heavy losses in the future if the investment fails.
Private Equity & Fintech
The global fintech market value stood at $127.66 billion in 2018 and is expected to grow to almost $310 billion through 2022. Within fintech, the payments ecosystem is expected to drive major growth, leading to a forecasted revenue of $207.11 billion by 2023. It comes as no surprise then, that major private equity investors are looking for innovative solutions when it comes to payments, digital banking, and international remittances. In 2018, seven of the largest fintech deals were within the payments landscape.
Private equity investors looking to invest in fintech & finance seek out companies that can exceed their current performance — compared to venture capitalists, PE investors take an active interest in their investment. This is mainly because PE investments amount to a huge controlling share of the company. Private equity firms invest in companies that are able to display a secular growth track record in markets that have high barriers (so as to lessen the competition) and one that has the ability for a steady cashflow.
According to SP Global, almost half of the largest fintech deals in 2018 were private equity buyouts. PE investors are keen to invest in fintech when provided with a reliable business plan for example, US investment firm Silver Lake Partners has a keen focus on tech, and has invested in several fintechs such Lightbox and Credit Karma.
Private Equity Due Diligence
It is integral to the investment’s success that the due diligence is comprehensive — this means exploring past actions, present status, and future plans. Due diligence for private equity investments should focus on evaluating the scope of the current business model, the business plan, and the influence of both market drivers & competition on the potential performance of the company.
As experts fintech consultants, we’ve supported many private equity clients with their investments in fintech and payments. When we do private equity due diligence (PE DD), we perform a comprehensive commercial and technical evaluation. Here are three key questions we ask (among others).
The Private Equity Due Diligence Checklist
How does the business plan fit in the competitive landscape?
Assessing the current business plan as well as the future roadmap provides an understanding of the company’s long-term goals. When it comes to fintech, the landscape is continuously changing so it’s important that the target company adapt to these changes as well as make them profitable. It is just as important to check if the business plan can accommodate both tech and regulatory changes as well as there is constant innovation taking place in the fintech landscape. Evaluating operating margins and costs while benchmarking the same against industry averages is also a crucial part of conducting private equity due diligence. If the target company can display a propensity for multiple avenues of growth, it bodes well for the investment as it can garner revenue from a diverse number of streams. This can be verified through historical growth trends, expert interviews with the management, calculating revenue potential, etc.
How do the competition & market drivers influence the possibility of profit?
With a rising number of fintech companies across the globe, traditional financial players are also undergoing digital transformations in order to appeal to their customer base. When conducting due diligence, it is important to evaluate the influence of competitors on the products & services that the target company is offering. Competitors offering similar products and targeting similar audience segments should be evaluated in conjunction with market drivers that have the potential to influence profits. Competitors should be evaluated on the basis of the quality of the product offered, pricing, growth rate, cost structure, and current market share. Market trends such as regulatory changes, economic factors, etc. should be studied to gain a better understanding of the market for the product in question. If the market does not show promise of expanding, or is shrinking, it might not be a successful investment even if the product fares better when compared to competitors.
How strong are the relationships of the target company with its customers and suppliers?
Not only is it important to evaluate the influence of external factors such as competitors, changing industry trends, etc. but it is also imperative to review the relationship of the target company with its current customers. Interviewing customers to gain a thorough understanding of the services/products and how well they are received is an important aspect of private equity due diligence consultations. Evaluating the target company’s marketing and sales performances can also paint a picture of the target company’s efforts to increase customer numbers. Assessing the stability of the company’s relationship with its suppliers can also display how well the company in question can form and maintain strategic partnerships.
These are just three of a 100+ question checklist that we use while conducting due diligence for private equity clients. To know more about how we conduct due diligence, request a sample report here.
Since private equity investments require a more in-depth review of a potential investment, the due diligence consultations tend to be more comprehensive and demand more time and effort.
As experts in the fintech and payments sector, we have conducted due diligence for several private equity clients and supported their investments in this space. We also offer strategic planning and digital transformation services.
Contact us to learn more.