Cyber Due Diligence: Non-Negotiable for Private Equity Firms Success

Introduction 

Due diligence is a crucial step in private equity (PE) investments, involving a thorough evaluation of a target company’s financial, operational, and legal aspects to assess its risk and potential return.

The rise of cyber threats has made cyber security a critical consideration for organisations across all industries, including PE firms. As such, PE firms must now prioritise cyber security when evaluating potential investments to make informed decisions before finalising deals. However, many PE firms encounter challenges due to a lack of knowledge and formal standards guiding the cyber due diligence process, leading to potential confusion.

Additionally, common misconceptions about cyber security often prevent organisations from taking necessary actions to protect themselves and their data. This article addresses these challenges by outlining key cyber due diligence best practices specifically for PE firms. By adopting these practices, PE firms can protect their investments and ensure the long-term success of their portfolio companies.

The Importance of Cyber Due Diligence for PE Firms 

The significance of cyber due diligence in private equity cannot be overstated. It is a cornerstone of the investment decision-making process, enabling firms to identify risks and vulnerabilities within target companies. By addressing these concerns, PE firms can protect their investments and ensure the sustained success of portfolio companies.

Recent data from IT Governance highlights the urgency of this matter. Despite being early in 2024, the number of publicly disclosed incidents and know records breached has already surpassed the totals of 2023. This highlights the critical need for PE firms to prioritise cyber security in their due diligence efforts. 

 Top Four Risks to Explore During the Due Diligence Process  

When conducting cyber due diligence private equity firms should closely examine four key areas:  

Technology Infrastructure 

Assessing the target company’s technology infrastructure is a crucial initial step in cyber due diligence. Outdated network equipment, systems, and applications pose significant risks, potentially leading to vulnerabilities exploited by cybercriminals.  

Consider whether its IT systems are modern and up to date and if there is a clear understanding of all IT systems, including those managed by third parties. Additionally, evaluate if these systems are suitable for the targeted market and if there are adequate processes and procedures in place to protect them. 

External Risks and Threats 

As organisations outsource key functions to focus on their core objectives and reduce costs, third-party data breaches have become more common. However, outsourcing services doesn’t absolve companies from vendor oversight responsibilities. It’s essential to review critical third parties with access to company data and conduct regular assessments of all third-party remote connections. 

Key considerations include whether third-party risk assessments and penetration testing have been conducted, if any past breaches or exposures have been identified and if the company complies with regulations. 

Cyber Awareness Culture 

Are employees adequately trained on cyber risk? What governance processes oversee cyber training? 

While a company may tick all compliance boxes during cyber due diligence, the security mindset of its leaders and employees is critical. Cyber security isn’t just a tech issue; it’s a people issue. A negative mindset toward cyber security can undermine even the most robust cyber plans. 

Ensuring top-down buy-in to security awareness is vital for evaluating a company’s security posture. Leadership must demonstrate a cyber-secure mindset and integrate cyber security into the organisation’s overall strategy. 

Incident Response Capabilities 

Does the company have cyber risk management procedures? How does it approach cyber from a general risk and controls perspective? 

As part of cyber due diligence, PE firms should assess the target company’s incident response plan, including procedures for handling cyberattacks, data breaches, or other security incidents. 

While organisations often prioritise attack prevention, detection, and response capabilities are frequently lacking. It’s essential to review the company’s incident response plan, its ability to detect and respond to attacks and conduct periodic plan testing. 

Controls and Coverage: Pillars of PE Cyber Security Due Diligence 

Once firms identify their cyber pain points, they can concentrate on strengthening cyber programmes to mitigate risks. These programmes should be grounded on two key pillars: controls and coverage.  

Foundational Cyber Security Controls 

Security Policies and Procedures

Ensuring the organisation maintains well-documented and current security policies and procedures is vital. These guidelines form the foundation of a resilient cyber security framework, delineating protocols for protecting sensitive data and addressing security incidents. Periodic testing of the plan ensures its effectiveness in real-world scenarios. 

Network Security

Securing high-value assets like customer data and business intelligence requires securing the network infrastructure. Implementing measures such as firewalls, intrusion detection systems, and encryption protocols is essential to prevent unauthorised access and data breaches. Additionally, conducting internal vulnerability scans and external penetrations as part of the cyber due diligence process is recommended to evaluate the company’s infrastructure and systems thoroughly. 

Identity and Access Management (IAM) and Insider Threat Management

Effective management of data access is crucial in preventing malicious internal actors from compromising security. IAM solutions play a pivotal role in controlling user access privileges, ensuring individuals access only the data required for their roles. Moreover, implementing measures to detect and mitigate insider threats further strengthens the organisation’s cyber security posture. 

Third-Party Vendor Management

While organisations often depend on third-party vendors for diverse services, these collaborations come with inherent cyber security risks. It’s crucial to comprehend and assess vendors’ security practices to protect sensitive data effectively. Contractual agreements should stipulate adherence to security standards and mandate regular security assessments to mitigate third-party risks. Reviewing critical third parties with access to company data ensures proper oversight, alongside periodic evaluations of all third-party remote connections. 

Employee Training and Awareness

Employees frequently represent the weakest link in cyber security defences. Offering thorough training on recognising and preventing common threats like phishing or social engineering attacks enables employees to proactively address potential security risks. Regular awareness programmes reinforce cyber security best practices and cultivates a culture of security within the organisation. Periodic reviews of security awareness training programmes are essential to gauge their adoption and effectiveness. 

Cyber Security Coverage 

Just as cyber threats evolve, so too must the measures private equity firms take to protect their investments. The decisions made regarding cyber security directly impact coverage options, whether through insurance procurement or self-insurance. Working together with a knowledgeable broker, private equity firms navigate the complexities of cyber risk management with a focus on informed decision-making. 

Conclusion 

Effective cyber security is crucial for private equity firms. As cyber threats increase, thorough cyber due diligence is essential to protect investments and ensure the resilience of portfolio companies. By conducting detailed assessments of technology infrastructure, third-party risks, cyber awareness, and incident response capabilities, PE firms can identify and address vulnerabilities, protecting their investments from cyberattacks and data breaches.

To manage this complex landscape, PE firms should focus on two key areas: controls and coverage. Implementing basic cyber security controls and understanding cyber security insurance options provide comprehensive protection against evolving cyber risks. Embracing cyber due diligence is not just about reducing risk—it’s about seizing opportunities and positioning for long-term success.

Equip your firm with the necessary tools and knowledge to handle cyber due diligence with ease. Contact us today to learn more about our tailored cyber security solutions and secure the success of your investment portfolio.