Importance of the Commercial DD
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As the Commercial DD is the one that settles the market conditions and evolution, which at the end define the profitability of your potential acquisition, do you think this should be treated as the most important DD?
HI Maracena, I think Commercial DD is often underestimated part of the due diligence, something you often keep for the post acquisition assessment, but in my view, the Commercial DD is one of the most important part, it is a key reason why you are acquiring the business (ok, sometimes it can be to get access to new technology, defensive acquisitions, etc), but in majority deals you want to acquire a business with solid potential, which is value-accretive for your business, which will help you drive sales and increase profitability.
Commercial DD is important to do an indepth analysis of the current status of the target and viability of the deal post acquisition.
I believe it’s a very important DD that isn’t utilized enough. For a highly successful M&A, conducting a holistic due diligence is more important. Capturing the cultural, financials, and strategic DD (where I would include the commercial DD) is essential for a smooth process and integration.
You bring up an important point! While all forms of due diligence are crucial in M&A, the Commercial Due Diligence does play a significant role in determining the market conditions and future profitability of a potential acquisition. CDD focuses on evaluating the market dynamics, competitive landscape, customer behavior, and growth potential, among other factors. By thoroughly analyzing these aspects, CDD helps assess the viability and long-term success of the acquisition. While it is important to consider other aspects such as financial, legal, and operational due diligence, the insights gained from CDD can greatly influence the decision-making process and the ultimate profitability of the acquisition. Therefore, treating CDD as one of the most important due diligence components is certainly justified.
As Jonathan mentions, other DD is just as important as commercial DD, but the difference between commercial DD and other DD is that it concentrates on the future growth potential of the buyer, which is very important when you want to acquire a company, because you wouldn’t want to buy a company that has no business growth in the future.
The commercial DD is really foucused on Risk mitigation. It helps identify and assess potential risks associated with a target company. (I.e. market conditions, competitive landscape, customer base, and regulatory environment).
The importance of commercial due diligence hinges on the specific acquisition and its underlying strategic rationale. An acquirer must meticulously analyze the target market and formulate a clear, actionable strategy to achieve their desired outcome. That’s before even looking for a company that matches its desired outcome. Commercial due diligence is instrumental in validating this strategy by providing a deep understanding of the target company’s strengths, weaknesses, opportunities, and threats. Depending on the acquisition’s nature and strategic goals, different types of due diligence may be more or less critical in mitigating risks and unlocking value.
While a commercial due diligence may provide crucial insights into the market viability and growth potential of the target company, a legal and tax due diligence (LDD and TDD) would in my view be equally important, as it can uncover legal and tax barriers or risk that, if left unaddressed, could fundamentally undermine the transaction or even the continued viability of the target company, even though it currently has future growth potential of the buyer, it has to be considered in the context of that target’s ability to achieve that growth. For instance, while a company can always enhance its commercial performance in future or pivot strategically or operationally, a failure to obtain a critical regulatory approval or permit which is required for the target’s operations could halt the transaction or the survival of the company, lead to significant penalties, operational shutdowns, or increased scrutiny from regulators. Furthermore, a historical tax liability can severely impact the financial health or investor attractiveness of the target or lead to overpayment of the target. We have seen cases specifically in the UAE and KSA where a tax liability, even though incorrectly issued, resulted in the failure of the target to find purchasers, or resulted in the liquidation of the company with the liability. I think these 3 areas therefore need to be viewed holistically.
For us, this is one of the most important elements of DD. Financial projections post-close impact overall valuation and strategy planning. We spend a lot of time analyzing customer “stickiness”; are they under contract? Have a purchase order on file? Will they continue to buy from us after the deal closes, or do we need to reduce projected revenues to accurately measure the financials?
Thanks
EdIn general, I suppose that financial DD, legal DD and commercial DD are equally important. The focus and depth of the DD needs to be defined in each transaction depending on the strategic goals of the buyer, the buyer’s already existing understanding of the targets bussiness model and the target alike. It very much depends on the industry of target company, the size of the target company, its age and the buyers knowledge about the target’s strenghts and weaknesses. For example, when acquiring an IT start-up company the focus will mostly be on commercial DD to analyse its growth potential, market, customers and its valuation while the DD of the historic financial might be not as demanding due to the short history of the company.
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