Private Equity

Commercial Diligence: 5 Tips to Assess Market Performance

Underwriting top-line growth is gaining importance as margin pressure and reduced cashflow impact traditional plays. Investors require a better understanding of the commercial capabilities they are buying earlier in the deal process. While many underwrite market growth only and view commercial optimization as an upside, it remains imperative to have a handle on the target’s ability to perform at or above market growth rates. Enter commercial diligence.

Commercial diligence is not market work, or the research and analysis to understand size, growth rates, competitive positioning and customer needs. Instead, commercial diligence produces an evaluation of the target’s go-to-market (GTM) model. It answers key GTM and growth questions and provides deal and operating teams with a line of sight into what’s needed to bring components of the deal thesis to life. It produces the initial value creation plan (VCP) management must execute to deliver the anticipated return.

Recently, Alexander Group hosted a Private Equity Insiders Council event to explore how firms are addressing the topic of commercial diligence. Over 50 deal and operating partners agreed that commercial diligence is now an important part of evaluating targets and creating the initial value plan. The group shared that they are operating in an environment of constrained access―in particular, confidential investment memos, management team discussions, and information provided via data rooms is especially opaque on commercial. These realities make getting a handle on what the firm is buying a challenge.

Many of the Private Equity Insiders Council members have increased their focus on commercial diligence. Backed by Alexander Group insights, the group discussed five tips to gain a better understanding of the ability of the commercial function to perform at or above market growth rates:

Talent – Understand the capabilities of the commercial team. One deal partner stated, “In many cases, we are betting on the management team.” To mitigate the risk associated with this bet, it’s extremely important to leverage precious time with the commercial team to gauge whether they have the capabilities to execute on the value creation initiatives and plays needed to deliver anticipated growth. Do they have the people needed to execute the value creation plan? Will they be able to recruit, onboard and retain the needed talent? How will historic turnover impede their success?
Process – Fundamentally, look for well-run companies. Understand their process discipline and focus on metrics. Do they measure the return on their marketing investments and the performance of campaigns? Do they have foundational pipeline and forecasting processes? Do they have baseline systems and data to effectively run the business?
Customer Engagement – Investigate how they interact with customers. Are they aligned with how customers prefer to interact? Do they have multiple channels and modes of engaging with customers? Do they have a strong understanding of the buyers and their value drivers?
Mid-Cap and Growth Equity – In these situations, M&A and GTM are often the biggest value creation levers. Unfortunately, as one council member put it, “Commercial is often a 2 out of 10.” The group also agreed that data and access are especially constrained on these deals. This makes meaningful commercial diligence challenging. The group advised to get a baseline understanding pre-deal but invest heavily in understanding commercial in the first 100-days. This includes spending time in the field with commercial team members and deeply understanding processes and operations.
Value Creation Plans – Stick to your playbook and focus on the highest probability value creation opportunities. Several deal and operating partners shared that they have built out playbooks that describe how they work with management teams to install disciplines that enable value creation. These playbooks might include pricing strategy, commercial excellence (e.g., revenue operations―data, reporting, processes), new product development and introduction, and many more. The group opined on the importance of moving quickly on these playbooks in the first 100-days to gain alignment and build momentum for what the business will accomplish over the next four to five years.

For more about Alexander Group’s Private Equity practice and the Private Equity Insiders Council, please contact a Private Equity practice lead.