If you’re an investor making new platform investments or a proactive company making add-on acquisitions, you know that due diligence is critical to the success or failure of the M&A process. For potential investors or acquirers of any kind, the process includes a range of activities, from understanding the management team’s capabilities to investigating the accuracy of financial reports to assessing the status and complexity of the target’s tech stack.
While all these measures are essential, perhaps no other due diligence topic is more important than understanding the attractiveness of a target’s end market and its competitive landscape. In the private equity industry, it’s well known that a bad market will overcome a great management team almost every time. But, on the flip side, when there is a great market and even just a run-of-the-mill team, the odds of success increase dramatically.
With this in mind, top private equity investors now use an approach called commercial due diligence performed by market strategy consultants to get an unbiased read on the attractiveness of a company’s end market.
In essence, commercial due diligence is another term for a market study. Larger, well-known strategy consultancies like Bain, Boston Consulting Group, or McKinsey usually perform the analysis. Or the acquirer can use more specialized boutiques with deep expertise in select subject matters or industries.
From an investor’s vantage point, the goal of the initial commercial due diligence process is to gain an objective view of a target’s addressable market size, its growth trajectory, and the competitive landscape, as well as the target’s key risks, differentiators, and untapped growth opportunities. While commercial due diligence may be a tried and true tool in M&A, like everything else its use cases and applications are evolving. By virtue of supporting the world’s top private equity funds and connecting them virtually every day with leading commercial due diligence providers, we’ve been able to see this product’s evolution in real-time.
Here are three trends CFOs need to know about:
In a recently released quarterly insights report conducted by our firm, we found that as valuations soar, private equity funds increasingly demand specialist commercial due diligence providers who can bring unique insights that can give buyers a competitive advantage. Investors are increasingly steering clear of generalist market study consultancies and moving to specialized groups with precise industry expertise. With deal prices at an all-time high and timeframes compressed, private equity funds can’t afford to buy a company just knowing the same information that everyone else knows. They can’t miss a critical insight or just flat out get things wrong because their provider doesn’t have an inside-the-market perspective.
Beyond Checking a Box
Back in the “good old days,” commercial due diligence (aka market studies) was more often used as a check-the-box exercise to confirm the seller’s information about market potential and opportunities. But now, investors also want to understand how they can best transform and differentially grow a business into something it may have never intended to be. Thus, acquirers use market studies not just as prima facie evidence to greenlight a purchase but more as a road map to confirm representations and inform unidentified value-creation opportunities.
Commercial due diligence has historically been utilized by upper market investors with flush budgets. However, based on what we’re seeing over the past 18 to 24 months, market studies are becoming a standard operating procedure (SOP) by investors throughout the private equity ecosystem, including the lower- and middle-market PE segments. Moreover, practices that start in private equity often find themselves in the hands of independent businesses not backed by private equity. Most buyers of companies with sufficient scale will (and should) be adding the commercial due diligence arrow to their quiver in the months ahead.
Understanding a target’s market dynamics is one of the most important things a buyer needs to do to be successful in M&A. But, before an organization adopts commercial due diligence as a standard practice, it should make sure it has the consulting group that fits its specific needs. It’s imperative that the service provider is actively performing commercial due diligence in the specific industry — and preferably has extensive experience with companies of similar size and in similar markets. Additionally, if your organization is new(er) to using this tool and doesn’t know the players, ensure that the consultant is deploying their “A-Team” on your deal.
An effective market study will help you build confidence in the M&A process while simultaneously confirming that the market opportunity is what the seller says it is.
Sean Mooney is the founder and CEO of BluWave. Prior to founding BluWave, he was a partner and member of the investment committee at SFW Capital Partners