Commercial and supply chain due diligence, especially involving your target’s customer base and suppliers, is critical for obtaining an accurate view of their operations and position in the marketplace.
The underlying goal must be one that presents a realistic view of the acquisition’s future growth potential with an assessment that relies on three distinct analyses: operational stability, market strength, and forecast validation.
Without a thorough review of each, you risk assuming vulnerabilities that can frustrate the most well-intentioned projections, dragging down earnings, increasing capital outlay, and ultimately the value of the return on your investment.
Commercial due diligence
While financial due diligence delivers critical details about historical trends, it’s important not to overlook an examination of recent and forward-looking business performance, which can yield important insights into projected future earnings. To that end, the due diligence process should include a strategic, commercial analysis to understand the critical drivers of future business performance, which will increase the value from your investment.
Consider these five areas:
1. Customer count
The true value of a company’s future earnings is directly tied to its customer base. To assess the strength of the seller’s customer portfolio list, analyze the customer base. Disproportionate revenues coming from a short list of customers indicate the sales revenue and profit may be less stable and too dependent on a narrow set. Spreading sales over a larger number of customers, however, can spread the risk.
The depth and durability of customer relationships are critical for meeting future revenue expectations. As such, it’s important to understand the relationship with the top purchasers, as well as the employees responsible for maintaining those crucial touchpoints.
2. Product line strength
No matter the strength of your customer base, you risk compromising their loyalties without a quality product line and innovation. Examine the seller’s portfolio carefully to gauge product stability, paying close attention to new offerings, and weighing those against the seller’s skill set and alignment with customer demands. Understanding their capabilities to utilize technology to create new products or services that can meet future market demands will be another key to unlock future value.
As to the seller’s skill set, verify whether those self-professed attributes are capable of delivering the results they promise. If not, you’ll need to determine whether those skills are easily obtained elsewhere — and at what cost.
3. Sales projections
If sales are spiking higher, look to see whether the increase is organic or attributable to risk-related events. If sales grew based on key events, distinguish whether the increase came based on fleeting changes or long-term industry trends, in order to gain an understanding of disruptors likely to create higher risk.
Assess whether forecast projections are logical in the context of your target’s customer relationships. For instance, if sales with a tech startup are projected to triple, commercial due diligence will flag the projections and develop adjustments reflecting a more realistic assessment.
Perform a comprehensive industry analysis to understand short- and long-term trends, noting any uncertainties. Some industries in particular need more scrutiny, including healthcare, energy, telecommunications, and manufacturing. You need look no further than the case of Blackberry to understand how quickly technology evolves, making it essential to review current industry trends and performance data to predict future performance.
4. Sizing up the competition
Assess the seller’s marketplace position and value propositions against those of its competitors. Like the Blackberry example, look for factors (i.e., technology, consumer preferences) that could threaten long-term financial health while charting the growth (or decline) of their market share. Understanding potential product substitutions emerging from competitors will help assess the level and timing of competitive risk. If there’s been recent M&A activity among competitors, that could also impact future earnings.
5. Selling dynamics
Explore the fundamentals of the seller’s sales organization to understand how business is secured and retained. Analyzing the sales and marketing organizations will reveal hidden and crucial business relationships and key factors of revenue growth. For instance, certain industries may offer ongoing price reductions to customers for long-term contract commitments. If this is the case, make sure the seller has been accommodating these unique expectations in their pricing approaches to ensure your post-integration projections of revenue and profit margin are accurate.
Supply chain due diligence
At a time when supply chains have evolved to become truly global and borderless, the risks for disruption have never been greater. Market fluctuations, volatile foreign exchange rates, political turmoil, labor shortages, global pandemics, and natural disasters all present risks that can interrupt the supply chain, causing part shortages and production slowdowns (or even shutdowns). In some instances, they can impact cash flow and trigger financial instability.
Recognizing the sizable risks the supply chain can pose, a critical element of your supply chain due diligence should include a comprehensive review of the target’s supply chain to properly measure your target’s risk, stability, and even potential for future growth. Evaluate the following areas to mitigate such risks:
1. Consider spend concentration
Look carefully at the spend concentration among suppliers, particularly for highly strategic/critical commodities and categories. If there doesn’t appear to be a balance of qualified suppliers in critical categories, this could be pointing to potential risk with supply chain disruptions.
Note any products that are procured from a single source. Such an arrangement may present profound risks, depending on the supplier’s stability, whether it offers backup facilities, and its sphere of operations.
2. Determine the supplier’s footprint
Assess the footprint to understand any known or probable risks, such as those related to geopolitical, disaster, political, economic, or environmental factors. And especially when the target has relied on a single supplier, understand the availability of other qualified suppliers, should an event compromise supply from the primary source.
3. Review contracts
For suppliers that provide critical products or services, it’s important to know the current commitments and terms and conditions that exist in the contracts — or whether or not a contract even exists. In addition, it’s helpful to know if the target presents a very small percentage of the supplier’s overall business. Delivery during a supply chain event may face a greater chance of disruption than if they represented a larger percent of the supplier’s business.
4. Examine supplier performance
Next, review all supplier relationships, assessing their performance and strength. The former is tied to specific metrics — cost, quality, and delivery — while the latter addresses more subjective dynamics based on trust, collaboration, and efficiency. Understand which suppliers are thriving and where there are opportunities for improvement.
5. Assess supplier management processes
Finally, while the target may (and should) maintain robust supply chain monitoring, does the supplier offer the same? Assess, if possible, the supplier’s qualifications and management processes of their supply chain. Such an analysis will provide a truer picture of the total supply chain risk.
Concluding thoughts
With so many moving variables — and so much at stake — during the acquisition process, it’s essential to know where to begin and how to break down your due diligence into manageable parts. Your target’s products, customer base, and revenue potential will be critical drivers of their top-line growth. Combining this understanding with their operational and supply capabilities will help identify the greatest risk factors in your investment — and finding these risks early on is a big step toward truly maximizing the value of your acquisition.
As you start the due diligence process, or if you’re unsure of the best next steps, please give us a call. We’re here to help.
