Private equity firms perform commercial due diligence (CDD) to evaluate the growth and profitability of a potential target acquisition.
A process that was once reserved for large cap funds with extra capital to spend on evaluating the soundness of the investment, CDD is quickly becoming a necessary standard operating procedure for all proactive PE funds.
“Each deal’s different and may require a different slate of providers to get the most out of each diligence phase or diligence stream,” says Keenan Kolinsky, Director and Co-Head of Research and Operations at BluWave.
Private equity firms have discovered that in order to drive alpha in a sea of beta, smaller, more specialized commercial due diligence providers can provide them with more unique insights quicker.
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What is Commercial Due Diligence?
Commercial due diligence is a systematic evaluation of a target company’s commercial viability before making an investment decision. It’s an extremely thorough process that, when done well, leave no stone unturned before papers are signed.
It comes as no surprise, then, that for the third straight year, CDD was the No. 1 due diligence category in the BluWave Activity Index.
From start to finish, it usually takes weeks, if not several months, depending on the target’s size and complexity.
According to KPMG, there are four types of commercial due diligence.
Here’s a high-level view of what the process entails:
Specialized Due Diligence
Any consultant can provide intelligence on a target’s total addressable market, prospects for growth, competitors, risks and other vital information through initial industry research. But specialized consultants with pre-existing industry knowledge don’t have to waste their time to gain a sense for the industry.
Instead, they can provide a heightened sense of value by using their base knowledge to dig deeper and therefore provide more in-depth insights in the same amount of time.
These steps give investors a deeper understanding of the target company’s business model, financial performance, competitive landscape, and operational and legal risks.
A benefit of specialized commercial due diligence providers during is their additional bandwidth. Because they aren’t being run to with projects across 8 different industries, they have the capacity to take on the projects that fall directly within their sweet spot.
Even when service provider constraints have strapped the market, BluWave has maintained a 100 percent fill rate with commercial due diligence requests.
How is CDD Performed?
Kolinsky says there are several variable diligence factors to consider, “such as the target’s industry, the deal size, target technology or operational nuances, timing and more.”
BluWave supports private equity clients by connecting them with the diligence providers whose functional capabilities, expertise and experience account for these different factors.
Here are some steps the service providers in the BluWave-grade network take when performing commercial due diligence:
Comprehensive Market Analysis
This is where the target company’s market position, industry trends and competitive landscape are analyzed. This helps investors understand the target company’s growth potential and market opportunities.
Financial Analysis
This important step includes a review of financial statements, balance sheets, income statements and cash flow statements. Doing so sheds light on profitability and liquidity.
Many firms seek outside help at this stage from a finance professional who’s gone through multiple commercial due diligence evaluations. In particular, an interim CFO may be a good resource in this situation.
Read More: Hire the Right Temporary CFO
Operations Analysis
This involves reviewing processes, systems and procedures to better understand efficiency, scalability and potential risks.
Just because a company isn’t operationally sound doesn’t necessarily mean it’s a bad acquisition target. A PE firm, however, will want to have a clear picture of its new asset before moving forward.
Legal and Regulatory Compliance
Evaluating the target company’s compliance with relevant laws and regulations helps minimize risks. Some examples include data privacy, product safety and environmental regulations.
Management Assessment
That is, looking at the management team, its experience, track record and alignment with the private equity firm’s strategy.
Preparing for Growth
The average holding period for PE assets is five years, which is a sound reminder that funds are often interested in forging long-term relationships with the companies in their portfolio. This is why it’s essential for the commercial due diligence process to be more than a routine vetting exercise and a perfunctory look at a company’s market.
It should help funds explore opportunities for growth and methods of adding value that can turn a company into something its leaders never imagined.
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We have recently seen many firms resort to a smaller, more specialized provider. They are permanently switching their processes to always using a specialized provider due to the valuable insights gained.
In times where other PE firms are struggling to get the right information on the timeline they need, equipping yourself with unique data quickly will provide you with competitive edge.
The expertly vetted service providers in the BluWave network have performed countless commercial due diligence analyses for hundreds of PE firms.
“In private equity, one size does not fit all,” Kolinsky says.
We vet each resource before they’re admitted into the network, and again before connecting them to you. After your initial scoping call with our research and operations team, you’ll meet the two or three “best fits” within a single business day.
Tell us about your project now, and we’ll get started with selecting your tailor-made solution.
