Posted onAugust 18, 2022
Buying an online business is certainly a huge opportunity and a huge risk. Most buyers screw up in two ways. They are blind to potential risks and they miss opportunities for value creation. That’s where due diligence comes in as a valuable and necessary asset in the acquisition process.
In this article, Centurica shares their 3 pillars of online business due diligence.
TABLE OF CONTENTS
Centurica’s 3 Pillars of Due Diligence
The 3 pillars of the Centurica Due Diligence Power Model are as follows:
- Financial: Verifying that the business is worth its asking price.
- Operational: Calculating risks within the business and identifying value creation opportunities
- Commercial (aka Market): Analyzing the market and ensuring that the future of the business is ripe for growth
Financial Diligence: Price Verification
P&L, COGs, and Quality of Earnings (QoE)
Coming into an acquisition the main question buyers want to know is, “Is this business worth what the seller is asking for?” Here’s how we make sure sellers don’t get away with misrepresentation.
At Centurica, we look at bank statements, bookkeeping software, and all the channels where payments come in. We get login access to everything so we can pull all the data. Once we have everything, we carefully rebuild the P&L from scratch. Then, we compare and contrast our P&L with the sellers.
COGS: Cost of Goods And Services
This area is where we often see big mistakes/differences. The seller wants lower COGS to make their business seem more profitable and attractive. The buyer wants what is most realistic. These two sides rarely line up 100%.
Another area that impacts COGS greatly, especially in e-commerce and FBA businesses is the volatile freight rates. COGS based on the last 3 months of freight versus the last 12 months will yield very different numbers. It’s not about right or wrong, it’s about reliable information so the buyer can have realistic expectations.
Quality of Earnings (QoE) Overview
QoE is about the sustainability of revenue and profits. This goes beyond the numbers and is a situation where an accounting firm has some limitations.
For example, let’s imagine a medical equipment distributor that had a significant increase in revenue during the COVID-19 pandemic. How sustainable is this revenue increase? In this case, the P&L may be error free but moving forward, the normalized revenue of the business may be significantly different than what the P&L represents.
Financial Due Diligence Summary
In essence, proper financial due diligence if done well, answers the following questions:
- Is the P/L correct and accurate?
- What discrepancies are there and why?
- Is the revenue sustainable?
Next, let’s dive into pillar #2: Operational Diligence.
Operational Diligence: Risk & Value Creation
Transferability, Risks, and Cost Savings
Operational diligence is all about uncovering risks and discovering opportunities. Operational diligence is split into three main areas: Transferability, Risks, and Cost Savings
Transferability is rather simple: Are you and your team able to take over this business and run it effectively? Here are a few things to look for that can help determine the answer.
- Key Person Risk Dependency: Is there one person who’s been running the business forever who has unique knowledge about the business? Could the business run without this person?
- Vendors/Partners: Will the vendors and partners continue to work with you? Lots of smaller businesses don’t have partnerships or written contracts, so this is important to look into.
- Team Members: Is the entire team coming with the business? Are they interested in working with you if you become the new owner?
- Technical Niche: Do you and your team have the technical chops and skills to run this business?
Keeping these thoughts and questions in mind should help you evaluate the transferability of the business you are looking at. Next, we will look at cost savings.
Obviously, this is all about cutting costs and saving money. Saving money and/or being more efficient with money can be a big area of improvement. Here are the main areas to explore.
- COGS/COS: Do you have a more optimized supply chain? Can you build a better service delivery that’s going to be more efficient and at a lower cost?
- Human Resources: Are you able to attract and hire talent?
- Process Improvements & Systems: Can you find ways to make things more efficient?
- Accounts Receivable and Accounts Payable (AR/AP): How can you improve the process of money coming in and out?
Operational Due Diligence Summary
In summary, a bullet-proof operational DD can help you get realistic answers to the following questions:
- If this business was ours now, how could we make this work?
- Where can I bring in efficiency to reduce costs?
- Where can I create value immediately?
Time for the last pillar of our power due diligence model, my personal favorite: commercial due diligence.
Commercial Due Diligence: Growth
External, Internal, & Growth Levers
Also known as market diligence, commercial due diligence is all about growth. It’s much more forward-thinking and about the future. There are three main areas for growth: external, internal, and accessing what I like to call growth levers.
This focuses on everything outside of the business that influences the business.
- What are key market drivers?
- What are the trends like?
- Will the key market drivers grow or shrink in the future?
- Who are the top competitors?
- What are your advantages/disadvantages vs target?
This aspect looks at everything inside of the business itself.
- Customer Analysis: Who are the customers and clients of the business you’re acquiring?
- LTV: What’s the average lifetime value of a customer?
- Churn: How often is this business losing customers?
- NPS: Does this business have an NPS? Can you run an NPS?
Lastly, you can simply look at the business plan as a whole. Can the business actually be improved?
Finally, we can look more deeply at some growth levers.
6 Growth Levers
- CRO: Conversation Rate Optimization. Ultimately, the question here is: Can you convert more of the current leads that you’re already getting into customers?
- SEO: Search Engine Optimization: How well is the business ranked versus its competitors?
- Pay Per Click (PPC) Optimization: Is there an opportunity for growth here?
- Sales Team. Can you improve the sales team and sales pipeline?
- Joint Venture or Partnerships. Are there opportunities here?
- Email Marketing Is there an opportunity to segment more carefully or add more follow-up sequences?
Conclusion: Become an Informed Buyer
So, there you have it: Centurica’s three pillars to due diligence. We hope you found this post useful and that these questions and insights can help inform your next acquisition. If you’re interested in learning more about Centurica’s services, our Market Watch app, or simply would like to connect, please don’t hesitate to reach out.