Areas of Due Diligence
A crucial part of the investment process is the due diligence performed on the company. Think of it like an investigation process for a potential investment: Cicero will perform very detailed due diligence in order to ensure that they are making a sound investment.
This process is crucial to the success of the investment, and the financial sponsor must look at all critical aspects of the target company: commercial, financial, and legal.
The vast majority of the time is spent on commercial due diligence while the financial and legal areas are more confirmatory in nature. Cicero relies on consultants for their expertise and advice for portions of the due diligence process, but ultimately the investment decision is the firm’s responsibility. This section provides questions and topics that are often evaluated while looking at an investment opportunity.
Commercial due diligence includes understanding the company’s value proposition, market position, historical performance, and industry trends in order to assess the target’s ability to achieve its forecasted projections.
Review Historical & Projected Financial Performance
Financial due diligence confirms that all the financial information provided is accurate and helps us understand some of the unique dynamics of the company from a financial reporting perspective. The firms typically hire accountants and/or auditors to review the financials, operations, customers, markets, and tax issues in detail. This is usually referred to as “transaction advisory services.” This analysis provides a deeper look into the company’s historical performance in order to understand how realistic the company’s forecasted projections are. Provide a comparison of the historical performance to the management budgets for the last 5 years. Describe the methodology behind the budget and the reasons for beating/missing the budget. What are the key performance indicators (KPIs) the management uses to monitor the business? Describe the trends in these indicators. Break out your organic growth over the last 5 years (not including the impact from acquisitions). Provide your 5-year financial model and describe the key drivers in your projections.
Due Diligence Questions
Competitive Landscape and Market Position
It is important to understand how sustainable the target’s business model is and where it is positioned relative to its competitors.
What is your competitive advantage (e.g. product offering, technology, price, premium brand, distribution capabilities, geographic presence, fully-integrated solution, etc.)?
Is this a disruptive business model (i.e., one that changes the landscape of how business is done in this space in some way)?
Industry Growth / Addressable Market
When evaluating the industry, it is crucial to understand the market environment and the external factors affecting the business.
Have there been any significant changes to the industry landscape (e.g. disruptive new entrants, consolidation, vertical/horizontal integration, demand/supply imbalance, etc.)?
This entails understanding the “stickiness” of customers and the company’s reliance on suppliers.
Capital Requirements of the Business
A good understanding of the total capital needed to run the operations of a business is needed, especially during difficult times.
What kind of lead-time is needed (i.e. time from purchase order to delivery) when making a purchase order?
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