Commercial Due Diligence (CDD) is the independent, expert appraisal of some or all of the ‘commercial’ elements of an acquisition target.
“Commercial” here usually spans most aspects of the business outside of financial and legal issues.
CDD may be undertaken purely for the potential investors: to reassure them that the descriptions given by the vendors, the vendors’ agents and the company’s management are reasonably close to reality, and that the future potential for the business is broadly as they claim. In other cases, work is also required by the banks and other financial institutions bankrolling the investment.
The output of a CDD project is usually a comprehensive written report, plus a ‘key points’ presentation; we are sometimes requested by our clients to make a presentation to third-party investors.
CDD is required in a higher proportion of M&A transactions in the chemical sector than many other industries as a consequence of the complexity of technology, value chains, market structures and competitive dynamics.
Size and Scope of CDD Projects
The size and scope of the work involved varies widely. Cogency recognises 4 discrete question areas that our clients typically wish to be covered – any combination may be included in our terms of reference:
1. Is the current business sustainable?
This focuses on downside risk: what could go wrong with the business as it stands today?
This is required in the majority of CDD projects, although the scope of the work may be wide-ranging or focused on just a few specific issues (possibly identified by an earlier ‘red flag’ report)
Depending on the investment model being pursued, a strong, sustainable business may in itself be adequate justification for acquiring it – some PE houses historically focused simply on acquiring safe cash flows; but in our recent experience, this is rarely enough today. Assessing sustainability of the current business is usually just the first hurdle in the process.
2. What is the potential for the business?
This focuses on the upside: “if we buy this business, how can we improve it, add value to it, reduce costs, achieve synergies – or simply accelerate its growth”? Fundamentally, this provides the justification for the acquisition – it is the “equity story”.
Management sometimes provides a well-thought out strategic plan for the business, and Cogency is requested to validate this – which involves identifying and prioritising the assumptions underpinning it, and providing a comprehensive objective assessment – see Validating the Equity Story
Sometimes the strategy may be generated by our client (their own ‘investment thesis’), rather than the target’s current management, but Cogency’s again may be asked to validate it.
Occasionally the upside is not well-defined, and Cogency may be requested to identify and evaluate strategic options, either working with or independently of the existing management team (this can continue post-completion).
Depending on the circumstances, our work may be externally focused (i.e. on market potential), internally focused (e.g. on cost reductions, areas where operational improvements can be made, or on synergies with other business units owned by the acquirer), or both.
3. What are the exit options?
If the acquirer is a financial investor, whose aim is to re-sell within perhaps 3-5 years, they must be confident that it will be possible to find a future buyer for the business – be this another PE house, a “trade buyer”, or conceivably an IPO.
Exit analysis is critical for two reasons:
o Vendors often exaggerate future exit possibilities: one obvious question is “why should trade buyer X buy the business in 3 years’ time (and pay more for it) when they have not bought it now?”
o Only if acquirers start with a set of potential “target” future buyers for the business in mind can they be sure of sanctioning only those strategic moves that increase its saleability.
4. What are the company’s competences?
In some cases, we are asked to assess management capabilities, internal processes, the new product pipeline, cultural fit with the acquiring business, levels of morale and motivation etc.
There are two benefits:
o Our client is reassured of the quality of the management and organisation of the business – or at least knows where problems are likely to arise and changes that may need to be made;
o If there is significant scope for internal improvement, this can be viewed as positive in that it adds to the potential upside for acquirer.
In addition, various other factors determine the scope of our Commercial Due Diligence assignments, e.g.:
• the quality and detail of documents provided by the vendors, also of management presentations;
• the extent of access provided to the company (which can vary from a couple of chaperoned interviews with just the CEO and CFO, to fairly open access to the whole senior management group);
• the access permitted to the company’s customers and suppliers
• the complexity of the business and the extent of our client’s confidence in their current understanding of it.
Cogency’s experience and assignment approach permit us total flexibility in defining a project to meet your requirements precisely.