Before reading this article, check out “Due Diligence by Management Consulting Firms”.
What is due diligence?
Due diligence is one of the most overused and understated terms in business. Due diligence is the process of being able to evaluate and understand a prospective investment, such as an acquisition, by gathering as much information as possible. In essence, due diligence procedures enable companies to gain knowledge and insights to empower their business decisions.
Different types of due diligence
There are multiple types of due diligence that provide businesses with the confidence and knowledge to get exactly what they want out of a prospective deal. Certain types of due diligence will enable companies to spot issues before they cause harm, while others provide valuable information on the true cost of a business transaction.
The most effective due diligence processes maintain close cooperation across the main categories which include commercial, financial, M&A, customer, technology, and vendor due diligence. This integrated approach to due diligence pays dividends as information gathered from one area can be valuable to another.
Commercial due diligence process
Commercial due diligence is the process a corporation or private equity firm undertakes to gauge a company’s commercial attractiveness. Unlike financial due diligence, which focuses solely on the financial health of the company, commercial due diligence provides a full overview of the target’s internal and external environment.
A commercial due diligence report analyses company performance, the likelihood that the business will meet its targets, and highlights potential problems that may occur following an acquisition. This report provides the potential buyer with in-depth knowledge of the target company and the market in which it is positioned. It is designed to enable the prospective buyer to make an informed decision, and highlight any potential risks associated with the target business.
Commercial due diligence is typically conducted before negotiations begin, to allow the potential buyer to assess the risks and potential of the target before making a bid.
The process is comprised of the following stages:
- A corporation or private equity firm will liaise with a third party (e.g. consulting firms like Bain, L.E.K., or EY-Parthenon) to conduct the process on their behalf. Outsourcing the commercial due diligence is usually done for one of two reasons: the acquirer does not have capacity, or they require extra validation as it is a niche area. Additionally, as acquirers often have only a few weeks to decide whether to make an offer, commercial due diligence projects usually last 2-3 weeks.
- The third-party then prepares a commercial due diligence report, outlining the information required for a potential acquisition. Information is usually gathered through:
- Primary sources (e.g. expert interviews – internal and external stakeholders, customer surveys, and social media monitoring);
- Secondary sources (i.e. desktop research, which involves looking into government statistics, company websites, trade publications, industry associations, and market research reports).
- The commercial due diligence report is then reviewed by the prospective buyer, in conjunction with other reports, before a final decision is made.
Benefits of conducting a commercial due diligence
- Informed negotiation: The primary benefit of conducting commercial due diligence is that it provides the prospective buyer with a thorough understanding of the target company’s position, before negotiations begin. This allows the buyer to make informed decisions during a potential acquisition.
- Assurance of investment: In addition, it provides an assessment of the external market landscape and what effect this may have on the target’s ability to reach its forecast results. It will also analyse competitors’ performance and market share. This allows the potential buyer to assess the target’s potential and determine whether an acquisition of the target is likely to yield a profitable long-term investment.
- Evidence for refinancing: Lastly, a commercial due diligence report can be used by the acquirer to show to their bank to provide comfort and reassurance that the business will not fail, and ultimately increase the target company’s credit rating or raise additional funds if needed.
Commercial due diligence checklist
A commercial due diligence report will vary depending on the nature of the target company, however the contents of the report will remain largely the same across most industries. Typically, the report will include, at a minimum, the following information:
- Target’s business plan and predictions:
- How realistic are these targets?
- How achievable is the business plan?
- Synergy:
- What kind of value can the acquirer unlock, either by changing the way the target is managed or by integrating it with the acquirer’s core business?
- Markets:
- Where is the target positioned within the market?
- What is the market size of the business?
- Where is the market heading? How could this affect the value of the target company?
- What are the trends in the market?
- Competitors and customer base:
- Who are the strongest and weakest competitors?
- How does the target perform against its competitors?
- What is its customer profile?
- Regulatory and compliance check:
- What are some regulations the target business must comply with?
- Are there any regulatory issues to consider, and how will they be resolved?
- Profitability and cost structure:
- Will the target reach its projected revenues?
- How much can the target company be expected to make over a set period?
- What are big cost components?
- How have average prices fluctuated historically?
- What is the forecast for prices in the future?
Once the strategy consulting firm helps with the successful acquisition it can later be brought in again in the second phase for post-merger integration work.
Jason Oh is a Senior Consultant, Strategy & Customer at EY. Previously, he was a Management Consultant at Novantas with a focus on the financial services sector, where he advised on pricing, marketing, channel distribution, digital transformation and due diligence.
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