James Tetherton, senior partner at GRAPH Strategy, explains how due diligence should be used to deliver improved commercial value.
Private Equity firms have raised unprecedented amounts of capital in recent years, and deal-makers are under pressure to put that money to work by investing in high-performing businesses.
However, the uncertain global environment, characterised by supply chain shortages, an increasing war for talent and rising inflation, mean that investors appear to be more cautious than they were a few months ago.
In this context, there is greater value than ever in high quality commercial due diligence, both for would-be investors to engage with a greater array of opportunities, and for business owners to create better growth strategies.
Commercial due diligence is now a widely accepted part of the deal process, and most prospective private equity investors will probably expect some work to have been commissioned by anyone seeking investment in their business.
Understandably, for many business leaders, commercial due diligence can feel like yet another hoop to jump through while navigating the investment process – one of many distractions and a further unnecessary tax to be paid on the road to deal completion. In those cases, commercial due diligence can become a “tick box” exercise that delivers little real value.
In contrast, when done well, great commercial work can provide a unique opportunity for the founders, owners and leaders of a business to take a fresh look at the company, and to develop a carefully crafted plan for future growth. Well-executed commercial due diligence offers a source of proprietary insight to answer the most critical questions facing your business, delivering strategic clarity and confidence to move the business forward at an even greater pace.
So, how can you ensure that your commercial due diligence exercise delivers real value? Here are five things that you should consider:
What are the critical questions?
Any commercial report needs to cover off on the core fundamentals that any prospective investor would want to understand about a business (for example, a review of the market size and prospects for growth, and a map of the competitive landscape). There are, therefore, a typical set of analyses and slides that most consultancies will reliably produce.
However – just focusing on these “tick box” questions can lead to a report that feels generic, and lacking real insight. Instead, management teams should actively engage in scoping work that meets your particular needs. What are the most difficult questions that keep you awake at night? What are most creative growth ideas that you’ve never had time to explore? Identifying and pressing on these issues will help ensure the final output captures the essence of what makes a business unique.
What are the right inputs?
Publicly-available market research reports provide a basic but valuable foundation for understanding a market. However, detailed investigation should involve conversations with a wide set of relevant stakeholders across the business, of which the most important tend to be customers (current, past and future prospects), competitors (particularly those larges firms which have been on the same growth journey), channel partners and others.
To be most helpful, these interviews should happen at meaningful scale, to truly gauge market sentiment and harness the ‘wisdom of the crowds’. Think in terms of 50, 100 or even more market interviews, not just a small handful.
What market are you sizing?
Almost all commercial reports include some reference to the size of market that a business plays in and most often, materials will reference an enormous total addressable market (TAM). The old adage of “the bigger the better” seems to be at play. In the context of a small but fast-growing business, these mega TAMs often feel irrelevant to the business and unhelpful to investors.
Far more valuable is a tightly-defined sizing which accurately reflects the serviceable market for ‘sweetspot’ customers. Armed with a solid sense of the true market size, management teams can more precisely explain where growth will come from and articulate a more compelling value creation story for investors.
Who’s doing the work?
The ultimate quality of any report is only as good as the team staffed to produce it. Discerning clients should think about who will be driving the narrative, conducting interviews, building analysis, writing slides and leading the thinking. How involved are senior partners vs managers vs junior consultants? How much does your work matter to the consultancy? What is their incentive to produce excellence?
Everyone has weaknesses – what are yours?
There is no such thing as the perfect business and any commercial report that claims otherwise will lack credibility in the eyes of investors. We often come across weaknesses – whether it be dissatisfied customers, issues around scalability, challenged differentation, or limited market headroom. It doesn’t help anyone to gloss over these.
A truly valuable commercial report will carefully attend to all shortfalls, identify the root causes and develop an appropriate plan to address these in the next phase of growth. Far better to be open and prepared than to take a ‘head in the sand’ approach and to hope for the best.