This GrowthTV episode is presented by the Association for Corporate Growth (ACG) and Baker Tilly.
Marc Chase, principal and private equity practice leader at Baker Tilly, joins ACG’s GrowthTV to talk about the importance of commercial due diligence.
Watch this video to get valuable insights from Marc on the key aspects and components of market diligence, and why it matters for private equity firms looking for successful investment opportunities.
00:10 - Katie: Welcome back to GrowthTV. I'm Katie Maloney, and I'm joined today by Mark Chase, partner in private equity industry leader at Baker Tilly. He joins me today to talk about market diligence. Marc, thanks for joining me.
Marc: Thanks, Katie. I appreciate the opportunity.
00:24 - Katie: So, I want to start by asking you what the key aspects of market diligence are.
00:29 - Marc: There’s a variety of aspects to market diligence. It's fairly comprehensive and extensive, but I think that the key components of it are the competitive environment, the customer journey, the trends for that market, any headwinds or tailwinds for the market validation. And really, as time goes on, these become more preeminent in looking at the potential for that investment thesis to hit its mark. So it's a very important aspect of the diligence process.
01:00 - Katie: And why should private equity firms undertake this as part of their due diligence? Why is it maybe more important now than ever? You touched on it a little bit, but if you can expand.
01:08 - Marc: So private equity is known for having the opportunity and having really smart professionals work on the financial model, on the financial structuring with private equity transaction. The market has become so efficient over time that the ability to get that efficiency in the structure of the financial transaction itself has become diminished. So you really have to turn your attention towards more diligence and getting outside of just the target company into the market itself. So what tailwinds will it face? What's the competitive environment? What's the segmentation of the market? Commercial diligence or market diligence really is the prospective look at the outside external environment of that target company. You know, most diligence processes are retrospective. What was the financial performance? What is the key aspect of the financial performance of that company? What is the environment that that company is actually going to work in, and what's the competitive environment look like? From a market diligence perspective, you really need to know not only who your direct competitors are, but who your indirect competitors are. So, market diligence should suss that out for you.
02:21 - Katie: Is there an example, either from a specific deal or even just theoretical to kind of illustrate this?
02:26 - Marc: Too many examples! I have a variety of examples for you. One aspect of market diligence and a key component of it is Voice of the Customer or Voice of the Client called a VoC. It's a small contributing aspect of the total diligence of market diligence. One aspect of that is we did what's called the Voice of the Customer, and it was both a survey and we talked to the top 10 customers who is a manufacturer, large manufacturer, been around a long time. We made these calls through top 10 customers. Well, during the process of those calls, we found that one of their customers, which was 8% of their revenue, was rechanging their own production line, which would no longer need a key component that this manufacturer was creating. Now that contract was going to expire in three or four months. So you would've never found that in financial diligence. Because that's all looking in the rear of your mirror. This is prospectively; as you're a private equity buyer, buying a target company, knowing that 8% of that revenue is going to dissipate or disappear, in three to four months, that's a huge thing to address during the whole valuation process and purchase process.
03:38 - Marc: Something more, not so much theoretical, but it's being proven right now - if you look at business models and competitive environments. Google right now is, in Australia and on the West coast experimenting with drone delivery. Now, if you are going to buy UPS or FedEx or some of these other delivery companies, it'd be kind of important to know what is the competitive environment, not just for your directing competitors, but your indirect competitors that are now creating technologies that will impede on your ability to deliver your service that you hadn't even thought of.
I don't think in any reasonable realm, you know, 10 years ago we would've thought that Google would be a package delivery competitor for UPS and FedEx, but the market dynamics and market diligence would show that.
04:26 - Katie: So Marc, you referenced a large manufacturer earlier. Does market diligence also apply to bolt-on acquisitions, or are we more talking about platform deals?
04:35 - Marc: It does apply to both. I would probably bifurcate that a little bit. If the bolt-on is in the same industry, in the same sector and has the same dynamics as the platform, then market diligence you probably have covered in your platform investment thesis. However, if there is a different aspect to it, you really want to understand what the uniqueness of that acquisition is dealing with and how to address it, to make sure that your investment thesis at intention is validated and you can actually use that as your ability to create your growth model going forward. So, your hundred-day plan, your KPIs, that market diligence would help create and monitor that add-on acquisition.