The 3 Pillars of Due Diligence
Due diligence refers to the comprehensive appraisal of a business undertaken by a prospective buyer, especially to establish its assets and liabilities and evaluate its commercial potential. All successful acquisitions begin with due diligence which involves thoroughly examining the financial, operational, and commercial aspects of a target business.
When he presented at this year’s #BossUp conference, Nate Ginsburg, the owner of Centurica, a consulting firm that specializes in this topic, emphasized the importance of this process for web-based businesses in particular. “Digital businesses are risky,” Ginsburg said. “You need an unbiased third party with experience to review every deal to ensure that you can buy in full confidence.”
But there are challenges. Buyers are often contending time constraints, limited by lack of expertise and ineffective communication with sellers. They may struggle with formulating the right questions or developing a structured process. Balancing costs and investments is also a challenge; buyers must weigh the expense of due diligence against the potential returns from the acquisition.
“The problem with most buyers is either they miss the risks of the business they're acquiring, or they miss out on opportunities for value creation,” Ginsburg said. He has two archetypes to illustrate two polar opposite approaches to due diligence:
- “Amateur Alex”: buyers who tend to regard the process as an expense rather than a form of protection. These buyers start the process late, seek the cheapest options, and lack comprehensive value creation and transition plans. Their short-term thinking and opportunistic mindset lead to delays, which can result in chaotic outcomes.
- “Professional Peter”: buyers who are opportunistic but cautious; confident but not overconfident. They appreciate the nuances in the target business and prioritize long-term thinking and strategic planning. Professional buyers are proactive, seeking the best help for optimal outcomes. They get ahead of timelines, develop value creation and transition plans, and present a strong understanding of the potential risks and opportunities associated with the business they are acquiring.
Ginsburg helms a team of experts with over a decade of experience in operating online businesses and, in his consultations, offers niche-specific due diligence advice for acquisitions. Here are his three pillars.
Financial Due Diligence: Verify
Are the seller's financials accurate? Answering this question involves rebuilding the profit and loss (P/L) statement to ensure the business is worth its asking price and to identify any discrepancies. This pillar focuses on assessing the target business's profitability, cash flow, and overall financial health. Key elements include analyzing the P/L, evaluating the cost of goods (COGS), and assessing the quality of earnings (QoE). Thorough financial due diligence gives buyers a comprehensive understanding of the target company's financial position.
Operational Due Diligence: Identify Risk & Value Creation
What are the biggest risks? Operational due diligence aims to identify both the risks and value-creation opportunities within the target business's operations. It involves analyzing factors such as asset transferability, key person risks, vendor relationships, and technical expertise. By evaluating these aspects, buyers can assess the operational stability, scalability, and potential for value creation within the business.
Commercial Due Diligence: Growth
Where are the biggest growth opportunities? Commercial due diligence focuses on evaluating the target business market potential. It involves conducting in-depth market analysis, competitor assessments, and internal customer analysis. Buyers can make informed decisions about the business's long-term viability and growth potential by understanding the market dynamics, customer demographics, and growth levers.
“I truly believe that now is the greatest opportunity to build wealth through business acquisitions in the history of the world,” Ginsburg said. “Though, this is only the case for professional buyers who know how to plan and take necessary action.”
PS: Our favourite sound bite: “It's not about finding a business with no risk; all businesses have some level of risk. It's about identifying the risk and being comfortable with it.”
Watch his full session from #BossUp 2023.
Opinions expressed here by contributors are their own.
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