Commercial Due Diligence – An Overview

What is Commercial Due Diligence?

Commercial due diligence is a step by step process that determines the overall value that can be generated from a merger & acquisition or an investment in another company. In the current market scenario, many entities acquire or invest in various private and public companies. The purpose of these acquisitions or investments is different for different entities. For example, one may want to invest in a start-up, acquire some unit to expand a vertical or merge with some conglomerate to create combined value. Whatever the reason be, everyone wants to be sure that the deal that they are betting their money on is actually worth the dime.

In other words, the commercial due diligence helps in assessing the potential viability and attractiveness of the M&A deals.

Why Commercial Due Diligence?

Firstly, the commercial due diligence is a very important part of a merger and acquisition. It is done side by side of a financial and legal due diligence. These are very important steps because lack of good due diligence can be a cause of the failure of a merger. According to a recent Harvard Business School report, the failure rate of mergers and acquisition are between 70% and 90%, and one of the major reasons for such high failure rate is inadequate due diligence.

Even if the deals may not be a complete failure, it may not generate the value that is predicted. Sometimes the deals wash out value instead of creating it. Harvard Business School’s report mentions some of the biggest examples of failed mergers and acquisitions in the past few years–

  • In 2015, Microsoft wrote off 96% of the value of the handset business which it had acquired from Nokia for US$ 7.9 billion.
  • In 2006, News Corporation had acquired Myspace for US$580 million, which it sold six years later for a trivial amount of US$ 35 million.
  • Google had lost US$ 9.6 billion in value when it sold handset business which it had acquired from Motorola.

The statistics and the numbers speak of the staggering importance of commercial due diligence.

Commercial Due Diligence

Areas Investigated in Commercial Due Diligence

Many critical areas are explored in commercial due diligence. Following is the list of key areas for due diligence –

Areas of Investigation – Internal Focus

In order to make a decision about mergers and acquisitions, one needs to know the target company inside out. This area helps cover the inside part.

Company Data – Overview of the Company

This investigation brings out the basic platform on which the company. Following questions are asked –

  • What does the target company stand for?
  • Which are its key products and services?
  • How are its revenue and profit center defined?
  • What is the company’s USP?
  • What are its core strategies and structure?

Therefore this area gives an overview of the target company.

Production, Purchase, Suppliers and Supply Chain

A second important area of any organization is its production and supply chain. Answers to the following questions are sought –

  • How technologically advanced are the plant and machinery?
  • What is the production capacity?
  • How many production facilities does the company have?
  • Is it sufficient to fulfill future demand? What are the future investment plans?
  • How are the supplier and distributor contracts? How much credit period does the supplier give to the company?

Answers to all these questions will give a detailed analysis of how well the target company is doing in terms of production and supplies. This is very important because these areas are key to customer satisfaction, and can add provide tremendous value on investment.

Organisation and Personal

Another very important area that defines the success or failure of the company is its employees. Good employees with well thought out organization structure and optimum company culture can be a deciding point in success. Following questions are asked during the commercial due diligence –

  • What is the organization structure in the company?
  • How big is the employee strength?
  • What is the quality of the workforce?
  • How good is the quality of management and board?
  • What initiatives does the company take for employee development?
  • What is the cost of maintaining the workforce?
  • Is the employee turnover rate high?
  • Is there a succession policy in place?

All of the above-mentioned questions helps in assessing the internal environment of the target company in the process of commercial due diligence. However, one must also understand assess the external environment in which the company is operating. The external environment is as important as the internal one. Let’s understand in detail.

Areas of Investigation – External Focus

Market Environment

The markets in which a company operates in defines its future growth prospects. For example, a company operating in the insurance sector will have a slower growth rate compared to a company operating in software services. Therefore, it is very important to understand the target company’s market environment. Following questions are asked –

  • What is the market size and market growth?
  • How is the market structured?
  • How is historic and projected growth rates?
  • What is the ease of entry and exit in the market?
  • Which are the market segments?
  • What are the current market trends?
  • Is it a buyer’s market or a seller’s market?

Competitive Landscape

Competitive landscape is similar to market analysis. The major difference between the two is that market analysis has more macro outlook whereas competitive landscape analysis takes the investigation on the micro level. The questions asked during this analysis are –

  • Who are the key competitors of the target company?
  • How is the market share?
  • What are the target company’s strategies to deal with competition?
  • What is the product USP compared to peer companies?

Sales and Customer Analysis

The area of sales and customer analysis is located somewhere between internal and external factors. It is neither completely internal to the company nor completely external. Furthermore, this is one of the more important analysis because sales and customers are directly related to the profitability of the company. The questions asked during this analysis are –

  • Does the company have B2B customers or B2C?
  • What are the types of customers that the target company serves?
  • Which segment do the customers belong to?
  • Are customers price sensitive? Are they loyal?
  • Does the target company provide credit to the customers? If so what are the debtor management policies?
  • How is the sales force? Are there third-party agents?

To sum up, if all these areas are investigated properly, it gives a very good overview of where the company stands. The goal is to answer a simple question – “Is the M&A deal going to bring value to the company?”12

1.
M&A: The One Thing You Need to Get Right. Harvard Business Review. June 2016. [Source]
2.
A Guide to Commercial Due Diligence. duedil. August 2019. [Source]
Last updated on : August 2nd, 2019
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