Commercial Due Diligence in the New Normality

As businesses have built resilience, the M&A sector is returning to a less erratic and more predictable trend. Many deals that were put on hold because of the health crisis are now resuming. 

New trends observed through the pandemic, however, may well have a long-lasting impact in M&A and related due diligence processes. 

A more risk averse environment has prevailed due to the pandemic generating “buyer friendly” conditions. For example, increased liability caps, longer limitation periods and fewer locked box deals have generally been observed. The Covid-19 pandemic has brought in more complexity in deal structures, and as a consequence the whole due diligence process has become lengthier and more meticulous.

So What’s the Impact on Commercial Due Diligence Processes?

FOCUS SHIFT: Due to fast-changing market conditions in the last 24 months, many previous considerations about target companies (e.g. business cyclicality and competitive landscape) are likely to be obsolete after only a few months. As a consequence, the focus of CDD has strongly shifted from extensive analysis of past performance to a closer attention to the future outlook. In particular, forecast assumptions  considered in the target company's business plan are being increasingly scrutinized and challenged.

RESILIENCE TEST: the pandemic has been a stress test for many businesses. From an investor perspective, the performance during the pandemic gives a useful picture of how agile and resilient a target company is. Most companies have experienced manufacturing disruptions, supply delays, reduced demand, increased customer churn, furloughing, temporary pay reductions, delayed customer payments and so on. Companies that changed strategy and stayed afloat showed strong adaptability to adverse market conditions, making them more attractive to potential investors.

ADDITIONAL QUESTIONS: Compared to pre-Covid-19 times, commercial due diligence providers are now tasked with answering a whole set of new questions. For instance:

  • How has the interaction between company and its customers and suppliers changed?  How secure is the supply chain? 

  • Is there any risk of goods or services being delayed by travel restrictions? What other logistical challenges exist? 

  • What is the new normality for the company? What is required to return demand or production to pre-Covid-19 levels?

  • Did supply chain shifts result in permanent threats or opportunities?

  • Do labour costs during the crisis reflect true ongoing costs? Did the business temporarily reduce employee salaries and suspend performance payments?

EBITDAC: ‘Earnings before interest, tax, depreciation, amortisation and coronavirus’ is becoming widespread as a way for vendors to better present recent sluggish results. Sometimes this can be useful to assess the real underlying performance in 2020. However, new considerations on EBITDA often lead to a whole new section of commercial due diligence checks to really understand what was the impact of the health crisis on performance and what is the new normal for the company.

REMOTE ENGAGEMENT: With social distancing and travel restrictions still in place, site visits by investors are less extensive and need to be backed up by more diligence interviews through video conference calls.

CASH IS KING: Finally, to address fast changing market conditions, vendors should be open to disclosing regular short-term cash forecasts covering a 12 week period to shed some light on operations, customers and the current order book.

Mario Lombardo