The value in an active approach with commercial due diligence
September 28, 2017 | NEWS
Tom Gladstone and Nicholas Farhi discuss how commercial due diligence can give private equity firms the edge in the bidding process.
By: Tom Gladstone and Nicholas Farhi
About $136 billion worth of private equity-backed buyout deals were announced or completed globally during the first half of 2017. While the transactions varied in terms of industry, region and size, they most likely had one thing in common: the input of a commercial due diligence provider during the deal process.
While a rigorous CDD process is essential to any transaction—revealing deal-breaking issues—PE firms could derive significantly more value from commercial due diligence providers. The right CDD provider, working for an enlightened acquirer, can help a bidder get an edge in the auction and to identify opportunities to improve the performance of an acquired asset that management and the purchaser might otherwise have missed. We define this as the “value-added” approach to CDD. Our view is shaped by OC&C’s experience as a provider of CDD on more than 600 transactions during the past five years.
The advantages to working with a CDD provider who offers a value-added process are clear. Armed with a better-informed perspective on the potential upside, a PE firm could submit a higher and more successful acquisition bid. In addition, by demonstrating a deeper understanding of the business, the PE firm will be positioned as a better “partner” for the acquiree’s management team—helping to forge a more productive working relationship, and becoming the preferred bidder in a tight auction. Finally, the CDD provider can help craft a specific plan of improvements that can be implemented in the first 100 days, enabling the acquirer to optimize optimize more quickly the value of the deal more quickly.
To illustrate this point, consider the example of a PE firm that OC&C supported in connection with the acquisition of a chain of gas stations. A passive CDD provider would have covered the basics: providing an
outlook for gasoline and diesel sales, modelling the impact on the business of a switch to hybrid vehicles, assessing the business plan, etc and so on. OC&C took an active approach, with a deep dive into the portfolio of stations and the ancillary services offered at each one. In the process, we identified some locations whose performance could be improved by replacing the station with a more modern facility, others where a less dramatic change (such as bringing on a new food partner) would be beneficial, and a group that could be left as is and run as cash cows. With this detailed roadmap in place, the acquirer was able to persuade management they would be great shareholders, and got an early start in driving performance and value.
We encourage both sellers and buyers of businesses to seek an active approach to CDD. It is a common practice with larger transactions in Europe, although less so in the U.S.S, to engage a consultant to conduct vendor due diligence (VDD). While the VDD approach is similar to performing due diligence on behalf of an acquirer, the result is an impartial report that can be shared with prospective buyers to provide a clearer picture of the potential value of the core business. When done well, a VDD establishes a common base of knowledge on the asset across multiple bidders and helps them get conviction on the base management plan. This allows bidders to focus their efforts on evaluating upsides, thereby achieving a higher exit multiple for the vendor.
To find a provider who can effectively perform value-added CDD, look for one with the deepest and most relevant expertise (for example, one who has not just opined on acquisitions of restaurants, but steak restaurants). Acquirers also should ask CDD providers how their evaluations have played out in practice.
Engaging a value-added CDD provider will not only help a PE firm avoid costly mistakes in the acquisition process, but also has the potential to deliver a greater return on investment.
This article originally appeared in Private Funds Management
Published: 23 August 2017