Commercial Diligence: 5 Tips to Assess Market Performance

Underwriting top-line growth is gaining importance as margin pressure and reduced cash flow 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.

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 are especially opaque on commercial. These realities make getting a handle on what the firm is buying a challenge.

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.

What Is Commercial Due Diligence?

Commercial due diligence is the evaluation a buyer makes of a target company’s commercial viability, market position and growth potential before deciding to make an investment. Commercial diligence is not market work. Instead, commercial diligence produces an evaluation of the target’s go-to-customer model and the company’s overall context based on its position in its market and how it will change.

It answers key go-to-customer 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 management must execute to deliver the anticipated return. Though it can take several months, due diligence for commercial applications is very thorough to ensure investors can be confident in their decision and be prepared for negotiations. Without commercial diligence, no parties involved can understand the business’s position or model.

The Commercial Diligence Process

Commercial due diligence involves the following stages:

1. Connecting with a due diligence firm: Alexander Group will conduct detailed diligence reports for the prospective buyer.
2. Preparing the diligence report: Alexander Group will create a commercial due diligence report with critical information like the company’s potential and market value.
3. Reviewing the report: The potential investors will review the report to assess its findings and ensure they understand all facets of the target company.

The due diligence report is a summary of the findings observed during the process. To create this report, Alexander Group will:

• Review the business plan: The business plan should define opportunities for income expansion and how these could be enhanced after the acquisition.
• Analyze the market: Investors must be aware of the target company’s primary competitors and market trends, as these factors can predict where the target company will fit into the market in the future.
• Examine the customer base: The report includes information about the customer base, like their profiles, lifetime, churn rate and experiences with the target company.
• Investigate financials: Financial analysis studies the target company’s sales, pricing and revenue projections. This part of the report analyzes the strategies the target company uses to enhance these efforts and whether they’re effective.

Benefits of Due Diligence for Commercial Transactions

Commercial due diligence for private equity investments offers several advantages. With due diligence, prospective buyers can:

• Be confident in their investment: In some cases, investors will need to acquire a loan from a financial institution to fund the purchase of the target company. A due diligence report can help investors secure the loan by presenting the company’s financial opportunities.
• Understand the competition better: Commercial due diligence examines the target company’s competitors and their effect on the market, which helps investors decide if acquiring the company is worthwhile.
• Forecast long-term success: Given the variables analyzed as part of the due diligence process, investors can better predict the target company’s future gains.

5 Ways to Gain a Better Understanding of Commercial Diligence

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:

1. 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?
2. 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?
3. 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?
4. Mid-Cap and Growth Equity: In these situations, mergers and acquisitions and go-to-customer 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, making meaningful commercial diligence challenging. The group advised getting a baseline understanding pre-deal but investing 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.
5. 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 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.

Learn More About Our Private Equity Practice

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