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Due Diligence services for digital targets
Professional transaction advisory by valuation of digital companies
During the last 25 years the global digital economy has grown rapidly. Thus, new successful business models were established, often by young companies. Such companies are agile and have an unconventional corporate culture. Their business models are for outside parties not always understandable and have different growth cycles. Sooner or later both already successful and “newly born” businesses will be in the focus of their bigger competitors, private equity firms and venture capitalists. Moreover, digital ventures need capital to grow and to establish themselves in the “winner takes it all” market. Investors, in return, require an assurance that their money will be invested properly. Both parties need a solid framework for an independent valuation of the intended transaction. Thus, a professional due diligence is of particular importance. FOSTEC & Company offers a portfolio of Due Diligence services, which may be divided into four (Figure 1).
Figure 1: M&A buy-side support by acquisition of digital & E-Commerce targets
The FOSTEC portfolio of Due Diligence Services thus consists of services of difference focus and different scope. The offerings range from initial Red Flag reports to full scope CDD reports which can also serve as a bankable report to secure the financing of the acquisition. FOSTEC & Company has already carried out a variety of Commercial Due Diligence Projects (Figure 2).
Figure 2: Selection of previously carried out Commercial Due Diligence Projects
The Commercial Due Diligence has generally the largest scope and includes services from the E-Business Due Diligence, the IT & Technical Due Diligence and the HR & People Due Diligence. The E-Business Due Diligence as well as the IT & Technical Due Diligence and the HR & People Due Diligence have a more focused scope and evaluate specific topics of a company.
While FOSTEC & Company possess Due Diligence expertise across industries, we have focused on the following branches (Figure 3).
Figure 3: Due Diligence industry expertise of FOSTEC & Company
Commercial Due Diligence (CDD)
The CDD´s purpose is to evaluate the target´s business model scalability. The CDD´s core task is to examine the target´s strategic fit to the investors´ portfolio. Next question is how large the synergies are which may be realized after the acquisition and how sustainable the collaboration with the target for the rest of the investor´s businesses will be. This will be achieved by analysing both the target´s present performance and the market growth expectations. In total, two internal and two external spheres will be examined, as shown in Figure 4.
Figure 4: Areas to be analyzed within the Commercial Due Diligence
First, the analysis of the external areas will demonstrate how attractive the target´s market is. Furthermore, FOSTEC will evaluate the specific framework conditions, which also impact the target´s business: degree of technology and economic development, market growth and trends, customer behaviour.
Second, FOSTEC & Company will analyse the target´s business strategy and core internal competencies. Thus, areas such as supply and value chain, target´s USPs, technologies applied and management power will be evaluated.
E-Business Due Diligence
Besides of the overall CDD approach an in-depth analysis of the target´s E-Commerce business is required. EBDD´s goal is to analyse the target´s overall E-Business maturity level. This will ensure that the investment decision will be grounded on the most relevant information analyzed by FOSTEC & Company: We focus on seven modules, as described in Figure 5.
Figure 5: Framework for the E-Business Due Diligence (EBDD)
EBDD starts with a critical analysis of the centrepiece of every digital company – its business model. Which value drivers and key success factors impact the business model? How good is the present KPI performance in the field of sales and (online) marketing? Which value growth potential does the business model have, if the present performance and strategy were considered? FOSTEC & Company will screen the target´s present revenue streams, KPI performance and relationships with suppliers to assess the company´s strategic positioning. Thus, the following steps will be conducted in Phase I, as shown in Figure 6.
Figure 6: Strategic analysis of the target´s business model
In the next step FOSTEC analyses the target´s present E-Commerce organization. For this purpose we examine the workflows, organigram and people to provide the buyer with a specific picture of the target´s real organizational capacities (see Figure 7). We draw a conclusion regarding the organizational costs, efficiency and performance as well as check the make-or-buy potential in the value chain. FOSTEC & Company also evaluates the target´s organization regarding the employees´ capacities, responsibilities and competencies. Furthermore, the target´s dependency on its key people (CEO, owner etc.) will be determined: What will happen with the company, if these people leave? Thus, goal of Phase II is to understand whether the target can realize the growth envisaged with the organization it currently has.
Figure 7: E-Commerce organization analysis
Customers are the most important asset of digital companies. Thus, in the digital economy the target´s ability to win and keep customers is its central USP vs. peers. FOSTEC will examine the present customer management from two different viewpoints: measurable (quantitative analysis) and not directly measurable (qualitative analysis) KPIs, as described in Figure 8.
Figure 8: Customer analysis
Investors should understand not only how the customer base grows, but also which Lifetime Value customers have and how high the customer acquisition costs are. These parameters depend on the customer service and customer satisfaction. Though, the reasons for the customer churn rate will be determined, too. FOSTEC will provide a conclusion on whether the target´s further growth is possible with the customer management it currently has.
Investors should also know which sales channels the target serves, how stable these channels are, and which channels can be acquired additionally. Moreover, the target´s E-Commerce success correlates directly with its online visibility. This factor is not constant but fluctuating and provides a clear picture of the target´s brand recognition. Thus, FOSTEC analyzes six areas within Phase IV, as described in Figure 9.
Figure 9: Traffic assessment
Target´s most important KPIs are the conversion rate and the cost of traffic generation. If these KPIs are satisfactory, it is reasonable to analyze the target´s IT systems.
Next, FOSTEC provides a holistic picture of the target IT systems´ stability, agility and future capabilities. Focus of the analysis is a balance between the target´s IT strategy and overall business strategy. What is less important is, i.e. if the server capacities are sufficient or the software licenses are available, etc. Goal of Phase V is to determine the IT systems´ importance for the target´s business success, to check the IT staff´s competencies and to examine the IT systems´ scalability for the further company growth, as shown in Figure 10.
Figure 10: IT systems analysis
Based on the requested data, interviews with the target´s top management and the IT architecture analysis FOSTEC determines risks, weaknesses, strengths and chances of the target company regarding its IT systems.
Market analysis provides investors with a clear understanding in which market environment the target operates today and how attractive this market will be in the future. FOSTEC analyzes the target´s core markets via the strategic framework, presented in Figure 11.
Figure 11: Market & eco system analysis
FOSTEC also identifies present and expected risks caused by disruptive transformation of the target´s market and eco system and allocates the company after its growth stage in the digital economy. We consider not only direct competitors but also such players as Amazon, Google, Facebook, Apple and others, which disrupt markets where they have not been active previously.
The DD´s goal is the validation of the target´s business plan regarding revenue and profit. Both should be consistent with the insights gained in Phase I-VI. If they are not, appropriate adjustments should be made, resulting in a different target valuation. The methodology for the business plan validation is provided in Figure 12. Additionally FOSTEC determines commercial, technological and personal links between the real target´s value and the multiplier. Thus, the full-scope report provides a solid foundation for the price negotiations.
Figure 12: Full-scope report
IT & Technical Due Diligence
If you consider buying, for example, a software development company, then a deep dive IT & Technical Due Diligence is recommended. Specifically, FOSTEC will examine the code quality and the target´s IT rights / patents. Moreover, we analyze IT security measures, the development stage of the IT technologies as well as the software architecture of the target (Figure 13).
Figure 13: Relevant areas for IT & Technical Due Diligence
We also link the IT & Technical Due Diligence to the HR & People Due Diligence by assessing the companies development team, in particular their roles, competencies and capacity. For more information on the HR & People Due Diligence, see the HR & People Due Diligence section.
HR & People Due Diligence
As part of the Human Resources & People Due Diligence, the workforce and the most important employees in the company are subjected to a qualitative and quantitative analysis. In doing so, we determine which capacities the target company actually has and to what extent the targeted growth targets can be achieved with the existing team. In the digital industry, employee know-how is one of the most valuable and important resources, but since it is personal, it is a walking asset. Keeping knowledge and key people, i.e., the walking asset, reduces the risk and stabilizes the course of a transaction. Two areas are examined in this special due diligence, which flows into the walking asset strategy in the event of a continuation:
- Focus on walking ability in order to avoid sensitive weakening from emigrating assets.
- Identification of walking assets to identify relevant know-how of good employees.
- Development of the walking asset strategy to keep walking assets through intrinsic and extrinsic motivational factors.
Close customer relationships and special creative services are among the most valuable and important resources. In addition to these, technical know-how and competence in designing agile management structures / processes, as well as HR systems, are important skills. All these important assets that need to be identified and assessed are mostly tied to specific people. The first investigation focuses on which competencies and skills these are in a specific case (Figure 14).
Figure 14: The most important aspects for the identification of the relevant walking assets
The second analysis is directed inwards towards the workforce to identify the existence and quality of relevant know-how. In order to determine the current assets, the organizational and management structure is being looked at. Key positions and skills in the business, the current occupation, as well as areas of responsibility and decision-making competencies result in an overall picture of the business relevant people. The loss of these key walking assets and the simultaneous retention of low performing walking assets must be prevented due to the associated weakening of the business. As far as possible, the relationship structures of the walking assets within the company are therefore analyzed (Figure 15) to be able to assess the scope of the personal decision of a walking asset.
Figure 15: Identification of business relevant people
If a transaction is considered, the next step is to develop the walking asset strategy. This strategy, individually tailored by the previous analysis results, sets up an action plan to retain walking assets through internal and extrinsic motivational factors. Dealing with knowledge and competence within the company is particularly important in the context of a transaction. The standard consideration of employment contracts, deadlines and potential severance payments is the foundation for the walking asset strategy. To maintain a walking asset or to ensure a controlled exit, intrinsic and extrinsic motivators, determined in direct communication, open up the scope for strategic maneuvers. In the latter case, confidentiality clauses as well as new job appointments and training through professional employer marketing must be of elementary importance. Here, FOSTEC offers its clients access to our exclusive network of professionals and experts.
Among our last DD projects are consulting of a Munich-based investment bank by an acquisition of an online retailer in the field of sport equipment & apparel. Our goal was to examine the growth forecast, provided by the target. Furthermore, we examined which profitability potential may be realized through improvements in the present operations. As a result, the target´s final price was adjusted in the investor´s favour. More references are highlighted in Figure 16.
Figure 16: Selected project references in the field of Due Diligence
Our Due Diligence services are a solid foundation for investors´ strategic decision making in the field of digitalization and E-Commerce. FOSTEC & Company as on of Europe´s leading strategy consulting boutiques is looking forward to your requests regarding company valuation and Due Diligence.
Your contact for further questions regarding Due Diligence Services
Markus Fost, MBA, is an expert in e-commerce, online business models and digital transformation, with broad experience in the fields of strategy, organisation, corporate finance and operational restructuring.Learn more
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