In today's red-hot private equity market, it's getting much tougher to make rational, value-based decisions. With multiple bidders competing for assets, and sellers becoming increasingly sophisticated, the typical auction process is starting to resemble the process of buying a house in a week: you're forced to compete against five other bidders without really knowing what's on the inside.

The need for high quality due diligence has never been greater. In fact, it's becoming virtually impossible to achieve high performance in the private equity market without changing the way we handle due diligence.

Working together with Rajesh Sennik, who has been leading our private equity initiative in Europe, we have identified five criteria that define high quality due diligence, based on Accenture's experience in more than 100 transactions globally over the past five years:

1. Look forward, not backward
   At today's premium valuations, the majority of value in any asset lies in future cash flows. Our experience shows, however, that traditional due diligence is overwhelmingly backward-looking, focused instead on validating the information underpinning existing cash flows. While understanding the drivers of past performance and potential liabilities is important, testing the assumptions that underlie management forecasts for the future is the best way to get at the kind of intelligence that is really required for a successful deal.
   
   
2. Focus relentlessly on key value levers
   The ability to deliver future value will typically depend on a limited number of performance drivers. High-quality due diligence identifies the key drivers of competitive success up front and then tests them through focused data gathering and analysis, such as correlations with past performance, market insights, known competitor actions and operational context. This provides a rigorous reality check on management forecasts.
   
   
3. Stay scrupulously objective
   In accounting for expenses, advisor fees are included in transaction costs and treated as an expense for the target to pay when deals are successful. When deals are aborted, however, fees must be paid out of management margins. As attractive as success-based fees may be to private equity acquirers, they create an incentive to present data in a way that makes deals look as attractive as possible and encourage investors to bid and win. No matter how carefully advisors try to protect their objectivity, the very existence of success-based fees inevitably undermines the credibility of advisor recommendations. High-quality advice, in our view, should be free from commercial interests.
   
   
4. Insist on deep industry, technical and operational expertise
   Understanding how quickly external trends will manifest themselves, critiquing management plans for responding, and assessing the feasibility and timing of proposed actions all require deep understanding of the industry in question and significant operational experience. Our ability to draw upon the expertise of people who have been in the trenches—running call centers, managing supply chains or operating businesses—helps us spot flaws in management forecasts that others with less experience could miss.
   
   
5. Incorporate post-deal improvements
   In the 80's, private equity firms generated returns through good deal judgment (buying low and selling high). In the 90s, financial engineering combined with powerful incentives to management was the dominant strategy. However with the proliferation of funds and increased competition for assets, these traditional sources of value can be easily bid away in the auction process. In the future, the most successful private equity firms will bring experience in making more fundamental operational improvements in their portfolio companies. This adds to the complexity of the due diligence process, as it requires the ability to quickly identify and estimate the value of such improvements. However we firmly believe that the ability to visualize and capture this value will determine the future winners in the private equity market.