commercial due diligence

Conducting Commercial Due Diligence for M&A [Checklist]

Oct 06, 2021

Successful merger and acquisition (M&A) deals involve meticulous research. However, not everyone is good at it. About 46% of M&A fail because of improper target identification, inaccurate valuations, and subpar commercial due diligence.

How can you improve your chances of a successful investment? The solutions include a sound due diligence framework, an easy-to-follow checklist, and the right software. Keep reading to learn more.

The role of commercial due diligence in M&A

Commercial due diligence (CDD) analyzes a company’s internal and external operations, value, and growth potential for M&A. CDD goes beyond reviewing the financial health — it covers all facets of the business, including its competitors and the market itself.

The CDD should answer questions like:

  • What is the company’s place in the market?
  • How can the deal increase our company’s value?
  • What potential problems and risks do we face?
  • Is the merger or acquisition a viable investment, considering potential benefits and risks?

Answering these questions requires exhaustive research into the acquisition target. The process can be tedious, lengthy, and even disruptive for both parties. So, how do you make a CDD as quick and thorough as possible?

Due diligence process framework

According to the 2020 Deloitte report, successful M&A transactions are often the result of well-structured due diligence. You can bring order into this process with a proven framework:

  • Preparation. Both parties (buyer and seller) should sign a non-disclosure agreement (NDA) and letter of intent. Next, the buyer should assemble a due diligence team or hire a third-party agency to do the heavy work. 
  • Planning. Parties agree on the reasonable scope of data for disclosure and set timeframes. The seller then prepares the documentation for review.
  • External research. The buyers study the target company’s industry and market, leading competitors, and customer profiles.
  • Internal research. The buyer’s team reviews the seller’s business model, available assets, performance indicators, and organizational documents. 

The team doing the research documents the due diligence results and compiles a report. The final document should present the benefits and drawbacks of the potential deal.

Now, let’s talk about the main research points of interest.

Checklist for commercial due diligence 

A commercial due diligence checklist can help the buyer organize the research or analyze the written report done by a third party. As a seller, you’ll know what documents to prepare in advance to save time.

So, here are the core inquiry items for due diligence.

General information

A general summary of the company’s history and key operations helps to understand its standing and corporate structure. This data sets the stage for more in-depth research.

Points of interest:

  • Company’s profile (values, business mission, vision, and message)
  • Executive summary (market analysis, business plan, strategic foundations)
  • Business locations and jurisdictions where it’s licensed to operate
  • Overview of balance sheets, schedule of expenses, revenue margins, and projected profits
  • Ownership (documents regarding directors, officers, and shareholders, their agreements and rights in the company)
  • Reincorporation and restructuring documents
  • Amendments and corporate bylaws
  • Company’s unique selling propositions (USP)
  • Value drivers for the M&A (expanding the market reach, cost-savings, personnel or technologies acquisition)

Market overview

Before proceeding with a merger, you’ll want to analyze the industry, consumer trends, and current or potential competitors. This information should help you understand the market and the company’s position.

Points of interest:

  • Market size and segments
  • Market segment-specific trends, demand, conditions, and threats
  • Historical and projected market direction
  • Main drivers for the market growth
  • Barriers to entry
  • Economic and political risks in the marketplace
  • Major competitors (profiles, USPs, customer base)

Operations

Operational research examines the company’s business processes and operating model, including sales, marketing, and the supply chain. Plus, this data helps determine the possible areas of investment after the acquisition. 

Points of interest:

  • Key systems and processes (both internal and outsourced)
  • List of products and services (already sold and those in development)
  • Marketing and sales procedures
  • Supply chain processes (main suppliers, creditors, distributors, value-added dealers, and resellers)
  • Customer analysis (primary demographics, segments, churn rate, satisfaction rate, buying power, margin cost for acquiring a customer, lifetime value, and net promoter scores)
  • Summary of warranty claims and complaints
  • Key performance indicators

Human resources

Before proceeding with a merger, you should also do some company research, including the number of employees, policies, benefits, and compensation plans.

Points of interest:

  • Employee and staff development overview
  • Organizational charts
  • Performance assessment (competencies, capabilities, and skillsets)
  • Vetting and onboarding process
  • Payroll, labor, and employment documents
  • Wage, reimbursement, and pensions

Assets

This section includes the company’s tangible assets, including real estate and leased property. The CDD should also examine the IT infrastructure and assess how it integrates into the buyer’s systems.

Points of interest:

  • Company-owned and leased properties
  • Inventory documentation (item descriptions, costs, policies for storage maintenance)
  • Software and hardware used by the company (third-party, proprietary, and customized IT systems)
  • System age and usage level
  • Software licensing and IT outsourcing agreements
  • Policies for IT operations, cybersecurity, and disaster recovery
  • Details of data breaches and other security incidents

The research should look into the company’s terms and conditions for liabilities and possible regulatory and compliance issues.

Points of interest:

  • Compliance policies and standards of conduct
  • Licenses (governmental licenses, consents, permits, and franchise agreements)
  • Previous and current governmental investigations
  • Pending litigation
  • Financing agreements, loans, and credit lines
  • Potential antitrust problems
  • Court orders, judgments, injunctions, decrees, and settlements
  • Audit results and correspondence with auditors
  • Material reports to government entities

Accounting and finances

Accounting is the most tedious but critical part of CDD. It includes the analysis of the financial performance, revenue sustainability, and potential tax issues you may inherit.

Points of interest:

  • Primary financial ratios (quick profit, gross profit, breaking-even, net profit, return on capital employed (ROCE), stock turnover)
  • Tax returns for the last three years (local and foreign income, sales, excise, and employment filing taxes)
  • Annual and quarterly financial statements (both audited and unaudited) for the last three years
  • Tax settlements and liens
  • Past revisions (internal and external)
  • Financial projections
  • Corporate governance and risk management policies
  • General ledger (equity and debt financing documents)

This list is by no means exhaustive, but it’s a good place to start. You need to customize your commercial due diligence process for specific markets and companies. And with so many documents to go through, you need the tools to smooth out the process.

Enhance due diligence with a virtual data room

Even the best framework won’t make up for poor communication, complex management, and poorly organized data. Thankfully, you can eliminate these problems with data rooms.

A virtual data room (VDR) is a secure cloud repository for corporate documents and sensitive information. 

However, VDRs are not like regular file-sharing services (Google Drive or Dropbox). Instead, data rooms are business-grade solutions with features designed for complex transactions. Their benefits include:

  • Robust security. VDRs adhere to international security standards (ISO 27001, SOC2, GDPR) and store your data on private servers managed by experienced personnel. Additionally, this software uses military-grade encryption and advanced authentication mechanisms.
  • Communication tools. Advanced communication features allow you to leave messages, comments, and annotations for files to get prompt answers.
  • Accessibility. Every authorized user can access the documents online and offline from anywhere. You can navigate through the user-friendly interface and find specific documents with a full-text search feature.

VDRs can streamline your business transactions by allowing you to review documents remotely in a highly secure environment. These tools are already helping thousands of companies in the UK and worldwide improve their due diligence process.

Bottom line

The commercial due diligence process is an essential part of a successful M&A, as it allows you to accurately measure the company’s value and meet the expected return on investment. 

Our checklist should help you streamline due diligence, reduce risks, and save time for both parties. And if you want to refine your due diligence process further, try enterprise-grade virtual data room solutions.