Commercial due diligence is the process a prospective buyer institutes in order to assess a target company’s commercial viability prior to purchase negotiations. The aim is to achieve a full overview of the company’s internal and external environment, highlighting potential risks and estimating the ultimate Return On Investment a buyer can expect.
The product of this process is a report outlining and analysing everything from the company’s recent performance and the scope of the market to competitor profiles, the company’s internal culture and the likelihood it will meet its current targets on time.
For this reason, commercial due diligence is a relatively complex undertaking, generally lasting 2-3 weeks and requiring a variety of research and inspection methods.
Why is Commercial Due Diligence Important?
There are three fundamental functions of commercial due diligence:
- To aid in negotiations by giving the buyer a clear understanding of the assets of the target company. This allows them to make more informed decisions and negotiate with a clear view of the true value on offer.
- To create confidence in the buyer, allowing them assurance of the target company’s ability to reach its forecasted goals. It also helps the buyer to understand the dynamics of the market the target operates in.
- To facilitate financing and support if the buyer requires it. A bank will offer better refinancing and credit options if a commercial due diligence report demonstrates that the target company is likely to perform well in the future.
Combined, they give a prospective buyer the level of visibility and operational knowledge necessary not just to decide whether or not the acquisition is worthwhile, but to actually run and – if necessary – restructure the business once the acquisition is made.
Who Undertakes a Commercial Due Diligence?
The vast majority of commercial due diligence is undertaken on behalf of corporations or private equity firms. However, a third party consulting firm is usually hired to conduct the actual process.
This is because the prospective buyer generally does not have the time, resources or specialist knowledge to undertake a thorough analysis of the target company. Outsourcing also means the process is undertaken from a more impartial perspective.
What is the Commercial Due Diligence Process?
There are three basic stages in a commercial due diligence:
1. The initial liaison between a prospective buyer and the third party they have hired to undertake the due diligence. At this stage the buyer will outline specific information it wants on the target company and set clear deadlines – generally to coincide with negotiations.
2. The report is compiled by the third part. This is the lengthiest part of the process and will typically involve conducting interviews and synthesising detailed research from a variety of sources – including trade publications, market analyses, government statistics and various forecast reports.
3. The report is reviewed by the buyer, and they will have the opportunity to probe aspects of the findings and analyses before making a final decision on the purchase.
What does a Commercial Due Diligence Report Include?
The report is generally intended to be exhaustive, and as such will generally be tailored to the specific industry and nuances of a target.
Beyond the basic facts about a company’s history, values, products and services, there are several core factors which any proper commercial due diligence report should touch on:
- Legal Status – does the company have proper legal documentation? Are there outstanding contracts or litigation issues? This will indicate not just the level of administrative work to be done but how well the company is currently being run.
- Plans and predictions of the target company – what are the company’s long term plans? Are its projections and targets currently feasible? This should give you not just a sense of the management and ambitions of a company, but the kind of culture and self-image it has.
- Internal culture – how do employees and management interact? What is the overall mindset and workplace dynamic? This tells you how effective a workforce you will be acquiring and how much restricting of personnel will be needed.
- Market and competition – how large is the market and who buys from it? Who dominates it and how is it likely to change in the future? This helps you contextualise the target company and see its potential for growth. It also helps you understand how challenging competing for market share will be.
- Financial model – what kind of revenue does the company generate and how? How have prices historically fluctuated and what is its potential for profit moving forward? This helps you understand more fully the business model, how cash flows and ultimately what funding and support will be required to make the investment profitable.
How to Improve Commercial Due Diligence
Commercial due diligence is a vital component of any serious acquisition, and while the traditional model has proven largely effective, there is still plenty room to improve the process and make more robust, better informed decisions.
According to the IMAA’s research, less than a third of due diligence processes included interviewing customers from the target company. For a commercial venture, this is unthinkable: what is more important, today, than customer service?
Commercial due diligence must seek to create a clearer sense of how the public interacts with a target company and how those sentiments are likely to shape the future.
It is also increasingly clear that supply chain management – from sustainability goals to supplier visibility – will continue to shape business performance in coming years, and including more vital information about how, where and why a business is sourcing its products will provide a level of strategic clarity many commercial due diligence reports lack.