When to Conduct Market and Competitive Diligence
The tradition has been for the buyers to have an independent third party develop a report covering an acquisition target's market and its competitive position in the market post-LOI. This document was frequently used to assist co-investors and lenders gain comfort in the investment.
Many PE’s are beginning to believe that this process is flawed and have begun to change the process. Most of our PE clients today begin market and competitive diligence early in the bidding process. As such the work can be fed into valuation scenarios. But more importantly, starting this work early can assist in determining early on if the PE should or should not “run hard” at the target. In today’s world of high valuations, running a full diligence team up to and through final bid makes no sense unless the PE is willing to move to a high valuation and has a hypothesis for value creation that is grounded in the real competitive world the target competes in. Today the early market and competitive work typically leads to either comfortably bidding up to with the deal, or getting out early and minimizing the lost deal costs.
But there is also another model. It began in Europe and is now spreading to North America. That model is for the sellers to have a trusted third party prepare the market and competitive report before the sale process begins. In the past the mantra was “don’t seek any outside assistance in the year prior to sale, it hurts EBITDA and the seller and the value will only go to the buyer.”
But this is not true. It is a clearly identifiable item that is part of the sale process and as such becomes an add-back item that is easily defended. Additionally, this new model can make sense for both the seller and the buyer.
- Bring in more buyers - Frequently the best companies are in niches. But the problem is that buyers invest in a wide array of industries and typically not only know little about the industry in general, they know nothing of the niche. As such, many potential buyers, without a good view of the market and the company’s position in it simply toss the teaser in the trash.
- Increase bid levels – when the buyers better understand, they can be more comfortable in building valuation scenarios that move to the level needed to win deals in today’s competitive world.
- Decrease post-LOI risk – When the market and competitive position is “good but not great” having an understanding of the position early can assist the conversation between the buyer and management and reduce the potential for a post LOI renegotiation, or a broken deal.
- Speed close – The buyer still needs to do their own full diligence work, including the market and competitive assessment. However, having the seller provided document can reduce the work, and the time needed, frequently reduced to only confirming the work and performing customer calls.
- Common view of the business – A sellers’ market and competitive report reflects the market and the company’s services as management defines them. As such it is the first step in getting the buyer and the management on the same page ready to jointly develop a post-close strategy
No matter if the work is performed by the seller or the buyer, the new model is that the most value can be created when the market and competitive diligence is begun early, and not post-LOI.