A Guide to Commercial Due Diligence
“I have never cared what something costs; I care what it’s worth” - Ari Emanuel
Typically, large businesses or private equity firms use commercial due diligence to make a judgement on whether an asset is worth investing in. The term can be used in other spheres like property, but the focus here is on company acquisition.
M&A deals are notoriously problematic and getting an acquisition right can’t be distilled into one formula, but a set of sound principles can help considerably.
Find Your ‘Why?’
Do not skip the question of thoroughly examining why you’re looking to acquire. Many businesses have ephemeral ideas about growth, strategic acquisition and revenue. The reason behind an acquisition needs to be a strong one – the upside must be big enough to mitigate the risk. So be absolutely sure the acquisition has a huge potential upside before going ahead.
In his book Lost and Founder, Rand Fishkin, the founder of software company Moz, rues a number of acquisitions he made because he lost focus on his core business – one of many risks.
A good tactic is to evaluate a target company from both sides, make the argument why you shouldn’t invest as really delving into this perspective will give a more rounded viewpoint.
A Costly Business
One critical question is on the opportunity cost of the acquisition: just because the acquisition may have a positive outcome it should be weighed against alternative options such as other acquisitions and different uses of capital.
The cost of time, human resources and management focus is likely to be significant so when weighing up the acquisition factor in these costs as well.
What You Should Cover
Any commercial due diligence process is a balance between cost and benefit. There is only so much due diligence that can realistically be undertaken though, obviously, the more significant the acquisition the more detailed the due diligence should be.
The Target Company – Strategic Direction and Management
You need to look carefully at the strategic plan – it should be clear and concise. Examine their strategy to understand whether or not it has been built on a robust hypothesis. A good rule of thumb should be whether they can explain their strategy in simple terms. If so, this demonstrates good clarity of thinking.
- Is the business built on solid foundations? Do the financials and business plan make sense and are they supported with the right resources?
- Is management concentrating on the right areas? Is there a clear focus for the business that has been rigorously benchmarked and tested against?
- Is there a trajectory which suggests future plans are realistic?
- How well has the management team dealt with setbacks?
- What is the record of the management team in this or other businesses?
The Target Company – Business Model and Financials
This looks at the business model and where it is positioned within the marketplace. Looking at areas like margin, defensibility, financials and competitive advantage should provide some insight.
- What pressures are there on margins?
- What is the marginal cost of each customer acquired?
- Are there network effects or economies of scale?
- What are the barriers to entry?
- What differentiates the business from competition?
- Understand the management accounts, including key rations and key metrics that drive the business.
- Are there synergies between the acquirer and the target company?
The Environment – Competition and Economics
Understanding how the competition works is important. Are all businesses operating with the same model and competing effectively on price and service, etc., or does your target business have a model which has key strengths over the competition? For example, using technology or having fewer overheads.
- Who are the main competitors and what are their strengths and weaknesses?
- What is happening to the overall size of the market? Are there new entrants and how does their proposition compare to the target company?
- What are the economic and political risks for the business? Can they be mitigated?
How Red Flag Alert Can Help?
At Red Flag Alert we are experts in business data – our software collates the most up-to-date information on every business in the UK on a daily basis. With over 100,000 changes every day on over 6.5 million businesses, we have data which will enrich any commercial due diligence process.
- Assessing a market is easy using Red Flag Alert. If you need to assess the financial strength of key competitors in a market you can view this key insight with Red Flag Alert.
- You can make judgements on the size of a market. Our advanced filtering allows you to create a list of the companies in your target firm’s market and then build a detailed profile of their size, structure and historical performance.
- Evaluate key management positions. With details on over 20 million key decision-makers, we’re able to provide background information on the key managers you’re negotiating with or those who will be managing your target company post-acquisition.
- Our platform helps businesses identify target companies to acquire – with detailed filtering by areas like size, financial information, geography and sector, you can shortlist businesses that meet your target profile.
For a free demo of Red Flag Alert to show you how we are perfectly placed to support your commercial due diligence process, please contact Richard West at firstname.lastname@example.org or on 0344 412 6699.