As a prospective buyer, commercial due diligence is a critical process that will help you determine whether or not a particular acquisition target makes sense for your company or private equity firm.
In this post, we’ll cover 7 areas that should be part of your commercial due diligence checklist to increase the odds of a successful deal.
By following diligence processes and thoroughly understanding all aspects of potential acquisition targets, you can reduce your risk and uncover any potential deal breakers.
What is Commercial Due Diligence?
Commercial diligence is the process of potential buyers (including private equity firms) confirming that all facts and information about a company match up with what was promised by the seller.
It involves collecting, analyzing, and verifying all pertinent information to assess the commercial attractiveness, market viability, and business plan of the acquisition target.
The goal is to ensure a prospective buyer can make informed decisions about the value of a business, strategic fit, and if a deal is worth pursuing.
Who Performs Commercial Due Diligence?
The buyer or an external third-party firm is typically used to perform commercial due diligence.
The third party will evaluate the financial, legal, and operational elements of a business before making any recommendations or decisions about whether or not it should be acquired.
What is Included in Commercial Due Diligence?
The commercial due diligence process (CDD process) can include:
- Understanding the company’s financial performance, current liabilities (including commercial property), and capital structure
- Evaluating the company’s business plan, products/services, management team, and future growth potential
- Analyzing its customer base, competitive dynamics, marketing approach, supply chain management processes, and other operational factors
- Assessing any potential risks associated with the market or competitive landscape (is there a hidden reason for selling?)
- Reviewing all internal policies and procedures to ensure compliance with applicable laws
What are the Benefits of Commercial Due Diligence?
Commercial due diligence provides numerous benefits for buyers when conducting acquisitions. It can help buyers or PE firms evaluate a company’s true value and understand any associated risks before they begin negotiations with the seller.
Does the M&A investment thesis still align with buyer expectations?Â
Additionally, it allows them to identify areas of opportunity that can be capitalized on after the acquisition is complete. Ultimately this helps to reduce risk while maximizing return on investment (ROI).
What are the Risks Associated With Not Doing Commercial Due Diligence?
When acquiring a business without performing adequate commercial due diligence, buyers risk overpaying for the company and taking on liabilities or risks they were not aware of.
Any discrepancies that are uncovered after the acquisition can lead to costly legal battles with the seller or potential third parties involved in the transaction.
For these reasons, it’s critically important to include commercial due diligence as part of your pre-acquisition process.
How Long Does the Commercial Due Diligence Process Take?
The amount of time it takes to complete commercial due diligence depends on the size and complexity of the business being acquired. Typically, it can take anywhere from one week to several months to complete a thorough investigation and create a commercial due diligence report.
Ultimately, performing robust commercial due diligence is essential for any company or private equity firm considering an acquisition. By following this checklist and evaluating all aspects of the target firm, buyers can reduce their risks while maximizing ROI.
Doing so can help ensure that any proposed acquisition deal is a good fit for their organization.
Commercial Due Diligence Checklist
There’s a lot to consider when conducting commercial due diligence, but here are 7 key things to keep in mind as a buyer:
1. Market Position and Competitive Landscape
It’s important to understand how the target company compares with its competitors and their relative market share.
- What is the target’s competitive position?
- Have they experienced similar growth as market peers?
- Which competitors represent the biggest threat to existing market share?
I’d recommend making sure the company is a strong player (top 3) within their respective market.
2. Market Analysis
Evaluate current market/industry trends and research any potential opportunities or risks associated with them.
- What is the expected industry growth rate?
- Does the market have enough growth headroom?
- Are there any risks that could impact the long term viability of the market or company?
3. Business Model
A clear understanding and analysis of the business model — including pricing, product mix, and sales channels — is critical.
- Is the company relying on a single product or service?
- Are they using a subscription-based model?
- Do they have any proprietary technology or processes?
- Is the target firm overly reliant on one new customer channel?
- Is there sufficient quality control for products?
4. Financial Performance and Growth Potential
A thorough analysis of historical financial performance and forecast (e.g., revenues, expenses, profits, cash flow).
- What is the likelihood that the target firm’s forecast comes to fruition?
- Does the company have a history of success with meeting projections?
- Is there future growth potential within the total addressable market?
- Are there other market segments worth competing in?
- Is the buyer confident that the management team will stay intact?
- Current marketing spend and potential improvement opportunities
5. Competitive Advantage
- Does the target truly have a sustainable, differentiated competitive advantage?
- How susceptible is it to disruption from existing or new competitors?
6. Customer Base
- Understand the demographic characteristics of existing customers and the ideal customer profile.
- What is the average customer lifetime value?
- Who their key customers are and what percentage of their revenue these customers account for. Is there any dependency risk?
- Assess customer satisfaction and NPS: what is the customer experience like?
- Retention rates and loyalty of existing customers
6. Synergies and Culture
- How well the products or services fit within your own portfolio?
- Are there are any opportunities for synergy or expansion?
- Is there a cultural fit and alignment with your existing business?
7. Intangible Assets
- What is the strength of the brand?
- Understand the value of existing patents, trademarks, and copyright
Conclusion
The due diligence process can be complex and involved, but it’s important to remember that it’s an opportunity to get a more complete picture about the business you’re considering.
As a prospective buyer, a thorough commercial due diligence report and analysis of the business plan can help you assess if the company is a good investment.
Whether you’re a PE firm or individual business, this knowledge can help you decide whether or not to proceed with an acquisition – so it will be time well spent.
