Commercial due diligence: scope, customer and expert calls, and a question list

Commercial due diligence checks whether a company's market and customers will support the plan you are paying for. Financial diligence checks the numbers the company reports, and legal diligence checks its contracts and liabilities. Commercial diligence asks whether the revenue will keep coming: is demand growing, do customers stay and spend more, and why do buyers choose this company over the alternatives?

Most of the evidence sits outside the company. You get it from public data, from the company's customers and lost prospects, and from people who work in the industry. The U.S. Small Business Administration describes an investor's due diligence review as a look at the management team, market, products and services, governance documents and financial statements; commercial diligence covers the market and product parts of that list. SBA: Plan your business

A worked example: route-planning software for food distributors

Suppose a small investment firm is looking at a company that sells route-planning software to regional food distributors. The deal, the company and its claims are hypothetical. The management presentation makes three claims:

1. Distributors are moving off spreadsheets, so the number of buyers is growing.
2. Customers rarely leave once the software is set up.
3. The product wins because it handles delivery windows better than general routing tools.

The price assumes all three are true. Commercial due diligence turns each one into a question you can test, then finds the people who can answer it.

Scope the work around the claims the price depends on

Write down the three to five claims the valuation relies on. For each one, note what would confirm it, what would disprove it and who would know. Leave out anything that would not change your decision.

For public data, the SBA's planning guide lists free federal sources, including NAICS industry codes, Census Business Builder and Statistics of U.S. Businesses. The same guide suggests market questions that carry over well to diligence: is there demand, how many buyers are there, how saturated is the market, and what do buyers pay for the alternatives? SBA: Plan your business

If a competitor is public, read its annual report. Investor.gov explains that Item 1 of a 10-K describes the business and may cover competition, Item 1A lists the most significant risks, and Item 7 gives management's own view of results and trends. How to read a 10-K The industry research guide covers more public sources.

Decide whom to call

A useful set of calls mixes people who like the company, people who left it and people who never chose it. In the example, a plan of about 15 calls might look like this (the counts are a hypothetical starting point, not a standard):

• Five current customers you choose yourself. References supplied by the seller were chosen for a reason. Ask for the full customer list and pick across size, region and tenure, with the seller's permission.
• Three former customers. They tell you why people leave. How to interview churned customers covers the approach.
• Three lost prospects. They explain what the competitor did better. See how to interview customers who chose another product.
• Four industry operators. Transportation managers, warehouse leads or IT directors at distributors that are not customers can explain how the job is done and how software gets bought.

Former employees of the company or its competitors can explain how the market works, but set limits first. Ask about their general experience, never about a former employer's confidential numbers or plans. What to do when an expert cannot share confidential information covers how to handle a refusal.

A commercial due diligence question list

Ask about what people have done, not what they predict. Adapt these to the claims you are testing.

For current customers

• What were you using before, and what made you change?
• Who chose this product, and who approves the renewal?
• What would make you switch next year?
• What do you still do outside the software, in spreadsheets or by phone?
• How has what you pay changed since you signed, and how did you react?

For former customers and lost prospects

• What did you choose instead, and what tipped the decision?
• What did the company get wrong during the sale or setup?
• Would anything bring you back?

For industry operators

• Walk me through how a delivery route gets planned today.
• When your company last bought software for this, who was involved and how long did it take?
• Which vendors come up when peers talk about this problem?
• What is changing in the business that would make this problem bigger or smaller?

The expert interview preparation guide covers how to order questions and follow up.

Keep the calls clean

Commercial diligence often touches companies whose shares trade publicly, either the target itself or its competitors. The SEC's position is that getting expert advice and analysis is legal, while trading on material nonpublic information obtained in breach of a duty to keep it confidential is not. SEC News Digest, February 8, 2011 Do not ask anyone for their employer's unreleased results, contract terms they are bound to protect or plans that have not been announced. This is general information, not legal advice; your counsel or compliance team sets the rules for your deal. The channel checks guide covers these limits in more detail.

Turn calls into findings

Go back to your claims table and mark each one confirmed, mixed or contradicted. Record how many people said what and who they were. "Four of five customers we picked said they would renew; the one who would not is the largest account" is a finding. "Customers love it" is not.

Weight answers by who gave them. A customer the seller introduced is more likely to be positive, and a former customer more likely to be negative. When sources disagree, see what to do when two experts disagree and how to check interviews against product data.

Your next step

List the three claims your price depends on and the roles of people who could confirm or disprove each one. If you need many calls across several roles, want an account team or your firm requires formal compliance checks, an expert network may fit better; the expert network companies overview compares the main firms.

If you can describe the people you need, such as "transportation managers at regional food distributors," Instant Expert finds people who match. You review who it finds, it sends your invitations, and you pay only for calls that get booked. The directory pages for operations professionals in food distribution and procurement professionals in food distribution are a place to start.