Commercial diligence has a fixed deadline that nobody negotiates: the bid date. We usually get three to four weeks. In that time we need to tell a fund whether the market is real, whether the company’s position in it is real, and whether the growth in the management plan is real.
Good diligence doesn’t answer every question. It answers the three that change the price.
It’s tempting to try to answer everything. The result is a 200-page report that arrives the night before the investment committee, and nobody reads past the summary. Good diligence doesn’t answer every question. It answers the three that change the price.
Start with what would kill the deal
On day one we sit with the deal team and write down the three or four things that would make them walk away or change their bid. Customer concentration above a certain level. A market that’s shrinking under the headline numbers. Growth that depends on one product or one salesperson.
Everything we do for the next three weeks is aimed at those questions. If a piece of analysis can’t change the answer to one of them, we don’t do it.
Talk to more customers, briefly
Our most useful source is almost always the target’s customers, and the customers who left. We aim for 30 to 50 conversations in two weeks, each about 20 minutes, with a short, consistent set of questions: why they buy, what they’d do if the company disappeared, and what would make them switch.
Thirty short conversations tell you more than ten long ones. Patterns show up by the fifteenth call, and the remaining calls test whether they hold.
Rebuild the growth, don’t review it
Every management plan shows growth. Our job is to take it apart: how much comes from price, how much from new customers, how much from acquisitions, and how much from one-off events. In one recent deal, a broker’s plan showed 7% organic growth. Without two small acquisitions and a one-off rate increase, it was closer to 2%.
That’s not a criticism of management. Sellers present their business well; that’s their job. But the fund needs to know which growth it’s paying for.
Tell the deal team early
The worst diligence finding is one the deal team hears for the first time in the final report. If a customer call in the first week suggests a problem, the deal team should know that afternoon, even if it turns out to be nothing. They may need to ask the seller for more data, adjust the bid strategy or bring in another adviser, and every day they lose makes that harder.
We send a short note at the end of every day: what we heard, what it might mean, and what we’re testing next. Most days it’s three lines. On the days it matters, it’s the most valuable thing we send.
A note on walking away
Sometimes the right answer is not to buy, at least not at the price on the table. That’s an uncomfortable recommendation to make. By the final week, the deal team has usually spent months on the target and wants it to work.
We say it anyway, and we say it with a number: the price at which the deal would still meet the fund’s return given what we found, and the conditions that would make it safer. A recommendation not to buy at 11 times earnings is more useful when it comes with the multiple at which you should.
What we leave out
We leave out market sizing beyond what the decision needs. We leave out detailed competitor profiles unless a competitor could take the target’s customers. We leave out anything already covered by the financial and legal advisers. And we leave out the 200 pages: the final report is the one-page recommendation, with a short appendix the deal team can actually use.
Before your next deal
Write down the three things that would make you walk away, before you hire anyone. If your diligence provider can’t tell you within a week how they’ll answer those three, they’re planning to answer everything else instead.
Keep reading
More essays by the partners on the decisions we see most.
