Whether you’re an owner looking to refinance, selling all or part of your company, or whether you’re management involved in such a process, commercial due diligence (CDD) is an increasingly indispensable part of deals – but what is CDD? And what are the typical types or associated terms around it? Chris Brown of our Strategy team explains.
The total due diligence process, whether the audience is corporate, Private Equity (PE) or lender typically includes a suite of financial, tax, and legal due diligence advice. Whilst these are reasonably well understood links in the merger and acquisition (M&A) chain, CDD, though common elsewhere, has been less well-known in Ireland to date.
Whilst every instance of CDD is specific to both the commissioning client and the ‘Target’ company, the purpose is straightforward: to allow an interested party to understand a target company in the required detail from a commercial perspective. This will normally include analysis of a wide range of commercially relevant factors, which, taken together, paint an accurate picture of the target business’s environment and its prospects within that.
But before jumping into the various terms, remember one thing – CDD is usually much lighter on management time than other forms of due diligence – after all, much of a CDD’s focus is about the commercial context external to Target and can therefore be researched independent of management diaries through discreet primary research and triangulation of secondary sources. The key management input is financial projections or a business plan – which may already have been captured in an Information Memorandum by your M&A advisor.
Types of due diligence
CDD is more diverse than commonly realised, being highly tailored in each case to a specific company and audience. Here we break down the main types and differentiate it from vendor assist.
1. Buyer-initiated CDD
In ‘buy-side’ CDD, the report’s duty of care is to the potential buyer (typically a private equity house or corporate) or lender, with the CDD provider commissioned specifically to advise the buyer on aspects of the Target’s current and future commercial performance. The exercise will be highly tailored to the specific needs of the buyer, but is likely to include:
- Target’s historic performance and forecasts benchmarked vs peers and market proxies.
- Sizing of end market segments Target serves, alongside Target market share at present and through the projected period.
- Peer, customer, supplier and regulator (where relevant) views of the competitor landscape and Target company position within it.
- Commercial integration or carve out considerations (for corporate clients).
- Scrutiny of market conditions and long-term viability of management strategy, including the viability of market drivers for 10+ years ahead (PE audiences will have their own ~5-year exit story to future bidders to consider).
2. Vendor-initiated CDD (VCDD)
Vendor-initiated CDD is, as the name suggests, commissioned by a vendor considering a sale, but carried out as an independent process. Agreed liabilities in relation to the report usually transfer to the eventual buyer. The duty of the provider is to provide an impartial, forward-looking view of the market, objectively testing key assumptions underpinning business growth forecasts, financial performance, competitive differentiation, and other aspects of management’s business plan.
In such cases, the provider will tailor their analysis of the Target business to serve the range of anticipated bidder types (e.g., PE audiences less familiar with sector fundamentals vs an international corporate audience familiar with their sector but less versed on Target’s specific differentiation or some local market characteristics).
The advantage of vendor-initiated CDD is that it is less demanding on management time – compare this single process to handling several concurrent buy-side CDDs from multiple bidders. While the CDD provider must maintain independence in reporting, a vendor-initiated CDD realistically affords Target management more opportunity to clarify points of difference and have early sight of drafts when compared to buyer-initiated reporting.
3. ‘Red flag’ CDD
Another term you’ll hear is ‘red flag’ reporting – this can be either vendor- or buyer-initiated and is a shortened reporting, focusing only on key items by exception. For smaller transactions ‘red flag’ reporting will often be sufficient and is typically anything between 20-50% the cost of a full scope CDD.
4. Top-up CDD
A vendor-initiated report, particularly a shorter ‘red flag’ report, will often be ‘topped up’ – this is buyer-initiated and rather than repeating the same ground as the VCDD, it aims to focus in on specific concerns the bidder may still have. It usually occurs only when a preferred bidder has entered exclusivity so as to keep the demand on management time low.
Not to be confused with…Vendor Assist
Many of the same skills that go into a CDD can instead go into a vendor assist role. This includes developing the business plan and helping Target management articulate their growth ambitions with a clear evidence base, and no requirement to be impartial. The data may be shared with prospective buyers, but no duty of care is owed to them. In such cases, the service provider’s role is to help the client articulate their strengths and the robustness of their business plan, and potentially surface pockets of trapped value within the business as well. In such cases the end product might:
- Provide evidence to investors that forecast growth is realistic.
- Ensure operating model and R&D investment is aligned with growth ambitions.
- Articulate existing ambitions, strategies, and management information.
- Build and integrate evidence missing from management’s existing business plan (e.g., relevant market trends, market share, competitive landscape analysis).
- Distil and present the growth story in a concise, investor-friendly manner.
Whether white-labelled as a management document, or feeding into an Information Memorandum, vendor assist can pre-empt some of a bidder’s concerns – and at least should make the subsequent CDD process more efficient.
What’s in it for end users?
For owners and management teams thinking about a transaction, the benefits of CDD far outweigh the costs. For example, a solid vendor-led CDD can:
- Pre-empt the inevitable battery of buyer due diligence questions, whether around growth rates, future value, competitive threats and positioning.
- Give early warning of potential impediments to exit or value-impacting issues.
- Provide prospective buyers with reliable figures and analysis for their own valuation and due diligence processes.
- Minimise time spent in the pre- and in-deal process, enabling management to focus on day-to-day business and saving the vendor time and money.
- Enable potential bidders to gain a focused, independent understanding of the business, and a grasp on company/geographic nuances.
- Underpin management forecasts.
Ultimately, commercial due diligence serves all interested parties when it comes to M&A transactions. It saves the vendor time and resources by anticipating the demands and questions of potential buyers. It enables PE buyers to gain a focused, independent understanding of upside and exit prospects, and it allows trade players to grasp relevant company specifics for integration.
Any questions?
If you have any queries on conducting commercial due diligence for your business, please contact Chris Brown of our Strategy team. We'd be delighted to hear from you.
Christopher Brown
Partner, Head of Strategy
KPMG in Ireland
