What is commercial due diligence?
Many factors can cause businesses to go bankrupt, and having knowledge of what these factors are will allow you see if your potential partner is vulnerable or not before embarking on a a Merger or Acquisition. A commercial due diligence helps shed light on the actual state of a firm or business, allowing investors to make informed decisions.
Investopedia describes Commercial Due Diligence as the process of verifying that a particular business is a legal entity and it has the requisite licenses to function as a legal entity. There are significant differences between due diligence and investigations. A due diligence review primarily seeks to verify that specific entities are not illegal, whereas an investigation seeks out illegal activities.
Fintalent’s Commercial due diligence consultants define it as the process of examining a business’s financial records and interviewing its officers, directors, and major stakeholders to determine its worthiness before making a decision to invest in it. It refers to an examination of whether a company or venture is worth investing in. It can also be referred to as “proprietary investigation”, “preliminary inquiry”, and “preliminary analysis”. Commercial due diligence includes interviews with the company’s officers and directors, as well as a review of the company’s financial statements.
Results of commercial due diligence
For a business entrepreneur, the results of the due diligence will help determine whether to proceed with the planned investment.
Use of a company due diligence report is not to be confused with “shareholder due diligence” (SDD) which refers to an examination that is made by an interested party when they are considering acquisition of shares in a public company. The interested party may use a commercial due diligence report from any source but often pays for it from his own funds and then uses it at his own risk. Shareholder’s may also carry out their own SDD.
Commercial due diligence as part of the M&A process
Commercial Due Diligence (CDD) is one of the most important phases of acquisition or merger in any business transaction, big or small. It is a time-consuming process that could cost you time, money, and risk. It is a very detail-oriented process that will examine all aspects of the company being considered and uncover numerous potential problems. A solid Commercial Due Diligence report can also uncover many beneficial issues pertaining to the target company; such as tax breaks, cost savings, revenue enhancements, negotiating power with suppliers and vendors.
A well planned and executed commercial due diligence process can be used to positively impact negotiations by helping two parties reach an agreement without going to court or arbitration.
The due diligence process allows parties in an acquisition or merger to better understand each other’s business operations, financials, current and future outlooks and risks. It is an important step to protect both their position and interests.
Time investment for commercial due diligence
Due diligence is a time-consuming process that could significantly impact an investor’s ability to close the deal on the agreed upon terms. You need to be fully prepared for what you expect to find out. You need to have your ducks in a row and your plan of action all ready as you head into the thick of things. A solid commercial due diligence process can save you time, money, and risk, but it comes with some caveats:
This process can take anywhere from 2 weeks to 6 months depending on the complexity of the company being examined and all its associated risks. A proper and thorough commercial due diligence process can be very costly. It is not just the cost of hiring a professional firm to conduct the due diligence that you must be prepared for. It is also the time it will take them to complete the process. If they find something they consider material and that you did not anticipate they are going to have to spend more time investigating it and that could mean another bill coming your way.
As part of your plan you need to give them permission for reasonable access to all employees, records, property, facilities, etc.. you may have to pay for the time they spend on the phone with employees, reviewing documents, and conducting inspections of your plant.
It is not just the monetary aspect that you need to be prepared for. There is also the possibility that their findings could cause a deal breaker. You can’t force an investor to proceed with a deal once due diligence has uncovered a problem. The best you can do is hope it doesn’t happen and then decide how to proceed from there. It could leave you in a very difficult position and force you into settling for less than what was initially agreed upon or possibly forcing you out of your business altogether.
The bottom line is that if you want to save money on a deal then do the due diligence yourself, if the investor wants it done by a firm then you will be better off hiring one from reliable sources such as Fintalent which offers a vetted community of tier-1 M&A and strategy talent as well as an array of qualified Commercial due diligence consultants.
Commercial due diligence can uncover many beneficial issues pertaining to the target company; such as tax breaks, cost savings, revenue enhancements, negotiating power with suppliers and vendors. It is not just limited to this alone however as it also helps an investor understand the climate of the market. This can sometimes lead to better deals or extensions that could be passed on to customers and suppliers. In some cases it can even lead to a termination of contracts or buying more on time than expected in order to meet demand.
12 Key Steps for carrying out effective Commercial Due Diligence
Fintalent’s commercial due diligence experts recommends the following 12 key steps for individuals seeking to carry out an effective commercial due diligence:
- Determine what kind of relationship you are looking for. Some businesses such as hospitality and construction may want to explore the possibility of doing business with a company. Other industries like mining and pharmaceuticals may not want to do business with an individual, as they often involve exceptionally large sums of money.
- Locate information online or via telephone. The information that you need may already be on the Internet. This is especially true if you are trying to assess a company or individual’s reputation.
- Check out the background information of any prospective partners. This can be either through the press clippings that the companies or individuals may have released about themselves, or by visiting their websites for more detailed information.
- If a company or individual has provided background information, contact them directly to confirm the information. If they are vague or evasive, do not continue with this part of the process.
- In many cases, there will be a conflict of interest warning in place. This could be via a press release, or it could be in the form of an electronic conflict of interest form. Be sure to check for these and make any necessary changes to your business plan accordingly.
- Check out other financial statements from third party sources such as Morningstar. Ensure that you have a solid understanding of what kind of return you can expect from this type of relationship.
- If possible, contact the company or individual directly to get a more direct feel for what kind of working relationship you are going to have. If this is not possible, ask them to provide a list of references.
- Have a good understanding of the financial backing available before you begin investing your own money and time into this prospective relationship. Things can go wrong and if they do, you want to make sure you have been indemnified appropriately according to the contract. This will help ensure that your investment is protected in case things go badly. If there is no contract in place, then be prepared for the worst case scenario when it comes to dealing with this prospective partner.
- Begin having discussions with prospective business partners about the kinds of legal protections that will be in place for you. This may include things like warranties or guarantees, or even indemnities against various normal business practices.
- Know when to walk away. If you have been doing your due diligence correctly and getting the same information from a number of different sources, you should be able to tell if this is a good deal or not. If a company is unwilling to provide any information, then that can be a red flag too. Consider whether this will be an actual partnership, or actually just a relationship where someone else has all the power and you have none.
- After the relationship, be sure to document your findings. If things go well, this will help you to remember why you chose this relationship and what went right during the course of your working relationship. If things go wrong, you will have documentation that can help you decide whether it is better to cut ties or try again in another way.
- Finally, use the information gleaned from the due diligence process to shape your future business plan and work towards creating a mutually beneficial relationship.
With these steps in mind, you should be able to conduct a successful due diligence on prospective partners.
