Project Hacks: How to Complete a Commercial Due Diligence
7 min read

Project Hacks: How to Complete a Commercial Due Diligence

A complete guide to writing a commercial due diligence from an industry expert, including special tips on how to do it quickly and effectively.
Project Hacks: How to Complete a Commercial Due Diligence

What is commercial due diligence?

Here how I would explain a commercial due diligence, or CDD:

  • It is an activity completed before an investment or transaction.
  • It mostly involved research and analysis on a company.
  • It is focused on validating the strategic grounding for proceeding with the investment.

The activities involved in completing a commercial due diligence are vital to provide the buyer with an understanding of a target company’s current market position and long-term viability. It allows all parties involved to make informed decisions and go into negotiations with an honest picture of the business and how it fits with their corporate or investment strategy.

When do you need to do commercial due diligence?

Anytime a company or strategic investor is considering making a meaningful investment. Typically, these investments will be on the larger side, in the tens of millions. The type of investment could be any one of the following:

  • Acquisition
  • Merger
  • Minority investment
  • Private equity investment
  • Venture capital investment

CDD is usually associated with an acquisition. However they should be done when considering all of the above investments. They are mostly outsourced to a consulting firm like McKinsey, BCG, Bain, L.E.K. or an accounting firm like Deloitte, KPMG, PwC or EY.

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How long should it take to complete a commercial due diligence?

This will usually be dictated by (a) the size and importance of the investment and (b) when the investment is closing. The shortest I’ve seen in a few days for a small venture investment, and the longest I’ve seen is 12-weeks for a big bet-the-company style acquisition.

However, your typical CDD will take 4-6 weeks.

What are the typical sections in a commercial due diligence?

There are just three sections in a commercial due diligence:

  1. Market
  2. Competition
  3. Financials & Valuation

Sounds simple, but it can be a boatload of work to fill these three sections. You are essentially trying to learn everything about a target company and deal, how it aligns to your company or investment mandate, and then distill this into a clear document.

How should you structure a commercial due diligence?

Here’s my preferred method: Split the team into three groups, with each group focused on one section. You will then provide oversight across the three teams to make sure the three sections are integrated, and run daily team meetings to share information between teams.

Here’s what each section should cover:

Market

The objective is to provide an accurate overview of the market the company operates in. The level of detail will depend on the importance of the deal, and the time and resources you have access to.

Key questions include:

  • How do you define the market?
  • How is the market segmented by customer, category and geography?
  • What is the size of each relevant market?
  • What is the historical growth rate of the market?
  • What is the forecast growth rate for the market?
  • What are the market dynamics and how are they changing?

Competition

The objective is to provide a detailed map of the competitive landscape and assess the relative strength of the target, buyer and the proposed combination of the target and buyer. Again, the detail required will be determined by your resources.

Key questions include:

  • Who are the direct competitors?
  • What are the relevant substitutes?
  • How do different companies compete in this market?
  • What is the positioning of each competitor?
  • How are the competitive positions changing over time?
  • What impact would this deal have on the competitive dynamics?

Financials & Valuation

This is where it all comes together. Usually another, completely separate, team will be looking at the financials in the financial due diligence. Financials here doesn’t mean looking into the ledger, accounting treatments, reconciliations of accounts, etc, etc. Financials here means looking into the financial forecasts provided by the target company and/or their advisors and using the research and analysis conducted above to determine whether they are a fair assessment of the companies potential future revenue and profit.

Key questions:

  • What is our assessment of management?
  • What are the management financial forecasts?
  • What are the CDD adjusted financial forecasts?
  • How do the implied valuation multiples compare to transaction and trading multiples?
  • What is the overall assessment of the valuation?
  • What are the risks and mitigations that can be applied to this deal?

Three fairly simple sections when looked at individually, and they are. The value comes in two places, (1) the insights you get when you spend time to really deep dive into a market and competitive landscape can be eye-opening to you and the buyer (and the target!) and (2) where it really comes together is taking this understanding of market and competition and comparing it to the forecast financials and valuation to determine whether they are justified.

It is a hard slog to complete but from this relatively simple process I’ve seen billions saved (and billions lost, when the conclusions are not followed).

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Who do you need to engage when completing a commercial due diligence?

A commercial due diligence requires engagement with a number of different stakeholders and parties:

  • Buyer: You either work for the buyer or they are your client. From them you’ll need to collect strategy artifacts and conduct interviews with subject matter experts and the executives sponsoring and integrating the deal.
  • Target: You’ll often (but not always) be able to engage with the target company to request data (market, financials, etc.), ask further questions to help support your analysis and request access to customers for interviews.
  • Advisor: More often the target will have engaged an advisor to run the process, if so you can engage with them for data requests, add questions to the data room, request interviews with management and customers, and get details on the deal process.
  • Information providers: There are many information providers that can help with ready made information to support the market analysis (e.g.,market sizes, growth rates, growth forecasts), competitor assessment (e.g.,competitor lists, competitor details) and financials and valuation (e.g., valuation multiples). Don’t waste time collecting this yourself if you already have access or have the budget and a reliable supplier.
  • Customers: Talk to customers directly to get insight on the market, target and its competitors. Use this to help understand why they buy, willingness to pay, risks of switching, etc. You can conduct interviews, or if you have the time and budget, use the ultimate CDD tool, a customer survey.
  • Competitors: Similar to customers, if you’re not breaking any confidentiality requirements there is nothing stopping you from talking to competitors (about the market and competition, NOT the deal). Or for that matter, visiting their stores, using their products, going on site visits, etc. For the really big CDD’s this is the extent that you are expected to go to.

Quite a few parties and moving parts involved. I may have left out a few there but using the 80/20 rule I think that covers it for the most part.

What are common mistakes to avoid when completing a commercial due diligence?

Here’s what to watch out for when completing a CDD:

  • Blind trust in information providers: I mentioned using information providers as a source of information, but I meant that you should use them as a starting point. Take their numbers and compare them, sense check and triangulate with other sources. Take your research, surveys and interviews and if possible, use them to show that the general markets growth estimates are vastly under- or over-stated. It is immensely valuable to an investment to have a contrarian view on the market.
  • Really weak competitor analysis: When you’re starting out with commercial due diligence (or any other project that needs a competitor assessment) it can be difficult to conceive of what a competitor analysis needs to include. So lots of people end up with a list of competitors, maybe mapped on two dimensions in a matrix. There’s lots that can be done to create valuable competitor analysis and I really prefer an opinionated competitor analysis. What’s their strategy, where are they strong, where are they weak, what acquisitions are they making, and why, what are their capabilities?
  • Lack of integration across market, competition and financials: The research and analysis should feed into and inform each section. Make sure that what you learn in one section is fed into the others. For example, market research on future growth rates should inform the growth rates you use in the financials & valuation. If you don’t integrate the sections then the CDD will be disjointed, lack clear conclusions and potentially even contradictory.

What are your top tips for completing a commercial due diligence?

I’ve completed 50+ commercial due diligence processes at this point. So I have a fair bit of experience and hard won lessons. Here are my top tips for making sure you and your stakeholders get value from the exercise:

  • Do a customer survey: If the conditions are right (e.g. a market with lots of customers) then always do a customer survey if you have the time and budget. This is my top tip. I did one once and our buyer let us survey their entire customer base of around 10,000 and they learned so much for the deal, and themselves. Super value add. Design it to get data on the assumptions you need to build your financial model. This data is PURE GOLD. You can use it in so many ways. With a well designed customer survey it will be hard NOT to produce a valuable and informative CDD.
  • Use appropriate tools and frameworks: Structure is really important for a CDD and using tools and frameworks is a good way to add structure and help the decision makers think through the implications of your work. For example, one of my favorite tools is using a “What You Need to Believe” slide up front to frame the choices. Showing that “What You Need to Believe” is the market growing at 100% per annum and the target company capturing 90% of the market is instructive and helpful. I’m exaggerating but you hopefully get my point.
  • Don’t bury the lead: Make sure you put your conclusions of all three sections clearly up front in an executive summary section. Don’t be unclear about what your recommendations are.

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