Commercial Due Diligence
Commercial due diligence (CDD) has become an essential component of various business deals, whether it involves refinancing, selling parts of a company, or engaging management in the process.
The overall due diligence process for corporate, Private Equity (PE), or lenders usually encompasses financial, tax, and legal aspects, which are well-established in mergers and acquisitions (M&A). However, CDD, although common in other regions, has been less familiar in Europe until now.
While each instance of CDD is tailored to the specific needs of the client and the target company, its purpose is clear: to enable an interested party to gain an in-depth understanding of the target company from a commercial perspective. This involves analyzing a wide array of commercially relevant factors that collectively provide an accurate picture of the target business's environment and its future prospects.
It's worth noting that CDD is typically less time-consuming for management compared to other forms of due diligence. This is because much of the focus in CDD lies on the external commercial context of the target company, which can be researched independently through discreet primary research and cross-referencing secondary sources. The primary management involvement often revolves around providing financial projections or a business plan, which might already be available in an Information Memorandum prepared by the M&A advisor.
Buyer-Initiated Commercial Due Diligence (CDD):
In the case of "buy-side" CDD, the primary responsibility of the report is to the potential buyer, typically a private equity firm, corporate entity, or lender. The CDD provider is specifically engaged to advise the buyer regarding various aspects of the target company's current and future commercial performance. This exercise is highly customized to suit the specific requirements of the buyer and typically includes the following:
1. The target company's Historical performance and forecast analysis compared to industry peers and market benchmarks.
2. Assessment of the target company's market segments, market share, and projected growth.
3. Examine perspectives from peers, customers, suppliers, and regulators (if applicable) on the competitive landscape and the target company's position.
4. Consideration of commercial integration or carve-out aspects (for corporate clients).
5. Thorough scrutiny of market conditions and long-term viability of management strategy, including evaluating market drivers for the next 10+ years (important for private equity audiences planning their ~5-year exit strategy).
Vendor-Initiated Commercial Due Diligence (VCDD)
In the context of mergers and acquisitions, typically the buyer takes the lead in conducting commercial diligence. However, it is also highly beneficial for sellers to undertake this process. Approximately 50% of deals fail due to issues discovered during the due diligence phase. Therefore, it becomes crucial for the seller to address these matters proactively. The seller can identify and resolve any issues by conducting due diligence on their own company before engaging with potential buyers.
This proactive approach leads to a smoother transaction and presents a more attractive deal to the buyer, often resulting in a higher value outcome for the seller.
Vendor-initiated CDD is commissioned by a company contemplating a sale but is carried out as an independent process. Any agreed-upon liabilities related to the report usually transfer to the eventual buyer. The provider's duty is to provide an unbiased, forward-looking view of the market, objectively testing key assumptions supporting business growth forecasts, financial performance, competitive differentiation, and other aspects of the company's business plan.
In such cases, the CDD provider tailors their analysis of the target company to address the various types of potential bidders, such as private equity firms less familiar with the sector fundamentals or international corporate entities knowledgeable about their industry but less informed about the target company's specific differentiators or local market characteristics.
'Red Flag' Commercial Due Diligence
Another term often used is 'red flag' reporting, which can be initiated either by the vendor or the buyer. This is a condensed report that focuses only on key items of concern. For smaller transactions, 'red flag' reporting is often sufficient and typically costs between 20-50% of a full-scope CDD.
Top-Up Commercial Due Diligence
A vendor-initiated report, particularly a shorter 'red flag' report, may be 'topped up' by the buyer. This additional assessment aims to address specific concerns that the bidder may still have. Usually, this occurs only when a preferred bidder has entered into exclusivity to minimize demands on management's time.
