Commercial Due Diligence Report Checklist

Commercial Due Diligence Report Checklist

Commercial due diligence is an important aspect of the pre-investment process for private equity firms. Today, traditional commercial due diligence has been greatly improved by the introduction of new data mining tools and analytics methodologies.

If you are searching for a partner to provide a modern commercial due diligence report, what factors should the report include? Quality data and predictive analytics produce quality answers, but no commercial due diligence report is complete without insight into trade areas, core customer definitions, competitive landscape, performance drivers, and growth potential.

Checklist Item #1: Trade Area Size

A thorough understanding of unit-level trade area size is the foundation of a comprehensive commercial due diligence analysis. All subsequent analyses will reference the trade area geography as the basis for measurement and SOM (share of market) calculations.

Trade areas are defined by the distance customers travel to visit the location and are frequently measured in drive times. The distance a consumer is willing to drive to interact with a location can reveal several defining characteristics of the target. For example, consumers traveling long distances may view the target as a destination location or consider the target to offer a superior product or service. Large drive-time trade areas can also indicate the presence of a market that can support additional locations. Often, trade areas will gradually shrink as new locations enter an existing market.

Trade area size also provides insight into tolerable levels of unit-to-unit cannibalization. Current fleet AUV reflects performance given any overlap across existing store trade areas. Understanding how performance is affected by trade area overlap is critical when assessing current runway.

Checklist Item #2: Core Customer Definitions

Building upon the understanding of trade area geographies leads to the development of core customer definitions. It is a common misconception that a certain type of household is a core customer simply because they visit a location in high volumes. To accurately define the type of households that have a high affinity for the brand, the volume of interaction with the location must be compared to that type of household’s presence in the trade area. A true core customer will visit a brand at a higher rate than their typical representation within the trade area.

Core customer definitions should not only capture the demographic characteristics of the customer but also include behavioral, psychographic, and life stage elements. Two individuals living next door to each other can appear to be demographically similar but behave very differently. Moreover, identifying core customers across life stages introduces an opportunity to harness the lifetime value of a customer. Greater returns on marketing dollars are achieved when marketers can precisely target the right households to communicate with, tailor content and messaging based on the type of customer, and engage through different channels based on customer preference.

Checklist Item #3: Competitive Landscape

Competition directly affects share of market and can vary based on several factors. Simply measuring the number of competitors within a trade area can lead to false conclusions.

Capturing a competitive element begins with understanding how competition behaves within the industry and market. Industries and markets with few alternatives do not exhibit the same competitive dynamic as those that are saturated. Additionally, industries with little product differentiation are obligated to compete differently. Many service-based companies benefit from co-locating with competitors. Effective commercial due diligence includes an understanding of these nuances and implements those findings appropriately when deriving share of market.

Checklist Item #4: Performance Drivers

Drivers and detractors of unit level performance extend beyond just the presence of core customers and competition. It is important to understand both the operational and trade area components that are conducive to outperformance.

In retail settings, co-tenancy and area draw can impact a location’s performance. Certain concepts may thrive in traditional shopping centers while others perform better as stand-alone units. Additional factors such as distance to major thoroughfares and co-location with companies providing complementary goods or services can also affect unit-level performance. Latent factors like brand awareness also have substantial effects on performance.

Checklist Item #5: Growth Potential Analysis

Perhaps the most important component of the commercial due diligence report is the growth potential analysis. A quality growth potential analysis will leverage trade area size, core customer definitions, and performance drivers to derive a bottom-up result that reveals the number of potential locations across the study geography that meet a minimum revenue threshold and do not overly impact existing locations in terms of sales cannibalization. Often, the potential location count and incremental revenue forecasts that result from the potential analysis become inputs to valuation models and inform appropriate bid size.

Quality is key. If the growth potential result is not precise then firms run the risk of bidding too high and paying too much, or bidding too low and missing out on a great opportunity. The growth potential output will also indicate which markets have the greatest potential and include insight into which markets are currently under penetrated by competing companies. Armed with this knowledge, PE firms can quickly execute on growth initiatives post investment. The roadmap has effectively been laid out.

The Bottom Line

Commercial due diligence is a crucial component of the overall diligence process, but not all commercial due diligence reports are equal. A comprehensive report includes an in-depth analysis of trade area geography, core customer definitions, competitive landscape, and unit-level performance drivers. Leveraging these components then informs the growth potential analysis, which is a critical step since the precision and accuracy of the analysis influences the accuracy of the valuation estimate and ultimately helps to right-size the bid. 

Buxton provides commercial due diligence analysis and reports that check all the necessary boxes. Learn more about our buy-side due diligence, sell-side due diligence, and tools for portfolio companies.