The target selection in leveraged buyouts : a risk appraisal matrix

Abstract

The goal of private equity funds is to generate satisfying results for their investors. In order to do so, they give a thorough attention to the selection of their portfolio companies. This process is called the due diligence. However, this process is lengthy in terms of time and efforts. The reports can be fifty pages long and, considering the number of deals envisioned by private equity funds, this makes it impossible for the decision makers to read all materials and therefore to have an exhaustive look of all the investments aspects. This study aims at helping managers with this issue by linking the practical and theoretical spheres together. This paper will therefore put under scrutiny the characteristics of strong LBO targets and the risks associated. From there, it will present a risk appraisal matrix which will serve as a thorough summary of the due diligence reports, an exhaustive checklist and a relevant risk appraisal tool. The risk appraisal matrix will be elaborated throughout this paper and corroborated with a qualitative and quantitative analyses. This scrutiny serves at corroborating the relevance of the matrix and providing evidence of its soundness. The matrix has nine sections, i.e. the description of the target, the acquisition environment, the management, the assessment of the business plan, the development strategy, the exit strategy, the valuation and return as well as the investment risks. Each section provides subcategories where the information and risks identified during the due diligence process are summarized and identified. A system of dropdowns and risk flags allow the readers to instantly and exhaustively appraise the risks involved with the potential investment. The risk appraisal matrix thus helps the private equity managers to save time, to better understand the target company and to make better informed decisions.