How to embrace the commercial due diligence process

James Tetherton from GRAPH
James Tetherton from GRAPH

Uncertainty means that private equity companies are scrutinising potential investments more closely than ever and anyone looking to secure investment should prepare for the due diligence process thoroughly, writes GRAPH Strategy senior partner James Tetherton

Supply chain shortages, inflation, rising interest rates and flagging consumer confidence are creating growing uncertainty for many business owners. Despite these challenges, the private equity industry retains a strong appetite to invest in successful, well-run businesses. And in these uncertain times, private equity firms can offer businesses much more than just additional funding. They also provide access to a wealth of experience, proven best practices and a network of experts with specialist knowledge.

Of course, uncertainty means that private equity companies are scrutinising potential investments more closely than ever, and anyone looking to secure investment should prepare for the due diligence process thoroughly.

Commercial due diligence is now a widely accepted part of the investment process, and most prospective private equity firms will expect work to have been commissioned by any business seeking investment.

Great commercial work provides a unique opportunity for business leaders to take a fresh look at the company, and can help to inform a carefully crafted plan for future growth. Well-executed commercial due diligence offers a source of proprietary insight to answer the most critical questions facing a business, delivering strategic clarity and confidence to move the business forward at pace.

To make the most of a due diligence process and attract investment, a business should consider the following:

1. Answer the critical questions - Any commercial report needs to assess the core fundamentals that a prospective investor would want to understand about a business (for example, a review of the market size and prospects for growth, and a map of the competitive landscape). However, simply focusing on “ticking a box” can mean that the work lacks meaningful insight.

Instead, management teams should engage in scoping work that meets their particular needs. Identifying and pressing on these issues will help ensure the final output captures the essence of a business and delivers real value.

2. Determine the right inputs - Publicly-available market research reports provide a valuable foundation for understanding a market. However, detailed investigations should involve conversations with a wide set of relevant stakeholders across the business, including customers (current, past and future prospects), competitors (particularly those larges firms which have been on the same growth journey), channel partners and others. To be most helpful, these interviews should happen at a meaningful scale to truly gauge market sentiment.

3. Consider the market you are sizing - Almost all commercial reports include some reference to the size of the market that a business plays in and most often, materials will reference an enormous total addressable market (TAM). For small but fast-growing businesses, these mega TAMs often feel irrelevant and unhelpful to investors.

A tightly-defined sizing, which accurately reflects the serviceable market for ‘sweet-spot’ customers is more valuable. With a solid sense of the true market size, management teams can precisely explain where growth will come from and articulate a more compelling value creation story for investors.

4. Recognise the value of teams and consider future talent - Without question, people make businesses and the investment market has matured in this area. Where investors were once concerned entirely with market demand and potential, they are now looking harder than ever at the potential to recruit, retain and build talent within the businesses they want to invest in.

Core questions being considered at the beginning of the CDD process centre around what the talent pool in the industry looks like and if the business can attract and retain enough talent to meet the potential demands of the market. Another key consideration is if the business can cope with an increase in wages to attract the best talent, and how this will affect the business, its competitive position and its future growth prospects.

4. Be honest about weaknesses and opportunities - There is no such thing as the perfect business and commercial report that claims otherwise will lack credibility in the eyes of investors. A truly valuable commercial report will carefully attend to all shortfalls, identify the root causes and develop an appropriate plan to address these in the next phase of growth. Far better to be open and prepared than to take a ‘head in the sand’ approach and hope for the best.

Ultimately, private equity investment enables companies to better exploit their potential. Their funds can drive business development organically, while their team’s expertise and contacts also work to a company’s advantage. This facilitates growth and strengthens a business’s offering. Business owners and leaders can take advantage of investment opportunities by ensuring they are fully prepared for the due diligence process.

GRAPH Strategy is a specialist strategy consulting firm that supports leading global corporations, private equity and credit investors to invest in and build stronger businesses. It adopts a rigorous, evidence-based approach to identify market opportunities, conduct commercial due diligence and design winning growth strategies.