How-to Guide · 11 min read
A framework for evaluating a business acquisition target
Introduction
Commercial due diligence (CDD) is the process of independently assessing a target business's market position, competitive advantage, and revenue quality before completing an acquisition. This guide covers the CDD process, key analytical workstreams, and how to interpret findings.
Step-by-Step
Effective CDD starts with clearly defining the investment thesis — why is the buyer acquiring this business, and what assumptions must hold for the investment to generate the required returns? Key questions CDD must answer: Is the market genuinely attractive? Is the target's competitive position strong and defensible? Is revenue quality high? Are management's projections realistic? Scope CDD around these questions — not as a comprehensive market study.
Competitive analysis assesses who the target competes with, how it wins and loses, and whether its competitive position is likely to strengthen or weaken. Primary research through customer interviews is essential — internal management perspectives on competitive position are systematically biased. A thorough CDD includes 10–20 customer interviews and 5–10 competitor interviews alongside desk research.
Market sizing in CDD requires independent validation of the target's view of its addressable market. Buyers often encounter targets with optimistically defined TAMs. A rigorous bottom-up market sizing — based on known customer counts, average spend, and penetration rates — provides a more reliable foundation than top-down macro estimates.
Revenue quality analysis is often the most valuable component of CDD. High-quality revenue is recurring (subscription or retainer-based), diversified (no single customer representing more than 10–15% of revenue), contracted (with multi-year agreements and switching costs), and growing. Red flags include high customer concentration, significant churn, or revenue dependent on unsustainable conditions.
Management projections must be critically assessed against market realities and historical performance. CDD examines whether projected growth rates are achievable given market size and competitive dynamics, whether margin assumptions are realistic, and whether the business can convert EBITDA into actual cash. Scenario modelling — base, downside, and stress case — is essential.
CDD findings must be synthesised into a clear overall assessment: does this business support the investment thesis at the proposed valuation? Key findings should be distilled into 3–5 'golden threads' — the factors that most determine whether the investment succeeds or fails. Red flags must be highlighted clearly, not buried in footnotes.
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