Management Summary

  • Status Quo: The private equity transaction volume in the first half of the year is at a record level in Europe – no slowdown expected
  • Private equity houses are faced with the question of focus on costs or quality when selecting consultants
  • Cost-effective consultants may not be able to recognize strengths/weaknesses as well, as work is standardized – qualitative consultants are more expensive, but work for this with an individual approach and have more industry knowledge
  • Companies from digital economy mostly pursue a different business model and the market is constantly changing, therefore the following is important for high qualitative work
    • Deep understanding of the digital economy
    • Strategic vision regarding e-commerce and digitalization
    • Strong network in the digital economy
    • Entrepreneurial mindset
  • Private equity houses should pay attention to the quality of the consultants, otherwise strengths/weaknesses will not be recognized and false predictions are derived.

 

1. Status quo: Private equity activity in Europe at record level

The private equity market in Europe is currently experiencing a massive upswing in transaction volumes. According to the research institute Refinitiv, the European private equity market achieved a transaction volume of USD 155.8 billion in the first half of 2021. This is the highest volume ever .  Compared to the first half of 2020, the volume thus increased by almost $100 billion (Cf. $59.1 billion transaction volume in the first half of 2020). Similarly, the number of transactions increased by over 50% from 991 to 1,585 transactions.

A slowdown in activity is not expected as private equity houses continue to raise money in times of low interest rates and low bond yields. The money raised further increases the pressure on investors to close deals, to use the available money and generate returns.

Deals are also eagerly being made in the digital economy in Europe. The current financing and investments include the following, among others:

  • Lending platform Younited receives $170 million from Goldman Sachs und Bridgepoint
  • AI company Tractable receives $60 million from Insight Partners and Georgian
  • AI company AskBrian closes funding led by FOSTEC Ventures

 

 

 

 

 

2. Commercial Due Diligence – A fine line between efficiency and quality

There is a fine line between efficiency and quality in due diligence for targets from the digital economy and setting the wrong priorities can be expensive for private equity investors.  At the beginning of an M&A process, the information asymmetries between buyer and seller are very large and a good commercial due diligence can reduce these asymmetries or even give the buyer a knowledge advantage in certain parts.

The advantages of standardising the commercial due diligence are obvious at first glance – results can be achieved cost-effectively and quickly. The contents and analyses are predefined and can be applied to all companies. In addition, the analyses can be carried out by junior consultants without specific industry knowledge. At second glance, the dilemma of the situation becomes apparent, since on the one hand, the business model of companies from the digital economy is usually very different from classic industrial companies and the industry itself is subject to strong and constant change. Standardized procedures usually cannot do justice to these specifics and the danger arises that priorities are set incorrectly and important findings cannot be uncovered.

In terms of industry specifics, the topics of operations and sales  are particularly worthy of mention.   On the one hand, the focus of value chain activities at traditional industrial companies is usually different than at companies from the e-commerce and digitalization sectors. Normally, the strong focus of traditional industrial companies is on operations, i.e. the production of products and the associated logistics. Since production and logistics account for a large share of costs at traditional industrial companies, small improvements already have a major effect.

In the case of companies from the e-commerce and digitalization sector, many areas of operations are often outsourced and taken over by service providers. The reasons for this are primarily the dynamics of the industry and the better scalability of the business model. By using specialized service providers, it is possible to fall back on existing infrastructures and the operations part of the company does not have to be set up itself. Furthermore, companies in the e-commerce and digitization sector often sell digital products rather than physical ones, for which traditional operations are not necessary.

Ultimately, this does not mean that the topic of operations is not important for companies in the field of e-commerce and digitization. On the contrary, the e-commerce business usually requires even better operations than classic industrial companies due to high customer demands on service/deliverability. However, the focus of the companies is not on their own operations, but rather on the cooperation with service providers and the IT systems used. This means that the skills of the employees as well as the IT systems used are much more important.

In addition to the example of operations, sales activities are usually also structured differently than in classic industrial companies. Through online sales, classic sales channels such as retail stores are replaced by online marketplaces or own web shops. Again, this does not mean that distribution is losing importance for companies in the e-commerce and digitalization sector, but that the focus is shifting. On the one hand, the area of D2C is gaining more and more importance and on the other hand, the KPIs that are relevant for sales are changing. The analysis of the achieved traffic on the marketplaces and own webshops as well as topics like Conversion rate, Advertising Cost of Sales or traffic sources gain massively in importance. Through increased direct and measurable customer interaction, marketing and sales activities can also be analyzed and evaluated more precisely.

 

 

3. Recommendation for action – No compromise on the quality of commercial due diligence

A standardized and thus efficient execution of a commercial due diligence bears the high risk that important strengths and weaknesses of a company are not identified. The previous section has shown that for companies from the e-commerce and digitalisation sector, the focus should often be on different topics than for classic industrial companies. Due to the high dynamics and constant changes in market structures in this industry, standardized approaches often cannot uncover and evaluate all the subtleties of the companies.

On the one hand, this means that standardized procedures are out of place in commercial due diligence. Every company differs in terms of the structure and focus of its business model and value chain. Standardized procedures do not do justice to this individuality and run the risk that important aspects of a company are analyzed insufficiently or not at all.

 

Figure 1: Success factors of commercial due diligence in the digital economy

 

On the other hand, the following requirements for a commercial due diligence consultant can also be derived from this for targets from the digital economy  (see also Figure 1)

 

  • Deep understanding of the digital economy:

In order to be able to evaluate companies in detail and identify strengths / weaknesses, a deep understanding of the digital economy is necessary.  On the one hand, typical problems of the companies can be better identified and focus topics can be evaluated and examined in more detail. On the other hand, strengths and optimization potentials of the companies can also be better assessed and thus the upside potential after the purchase can be optimized. As a result, the information asymmetries that exist at the beginning can be reduced overall or even shifted to the investor’s advantage in some areas.

 

  • Strategic vision regarding e-commerce and digitalization:

In addition to a more detailed examination of the company, future market developments can also be better assessed. Promising market areas can be identified more easily or negative developments in the company’s own market area can be foreseen. As a result, the company’s entire external ecosystem can be better evaluated. Recommendations for future strategy development or necessary transformation due to market changes can be identified at an early stage in order to initiate countermeasures in time.

 

  • Strong networking in the digital economy

A strong network of consultants in the digital economy has the significant advantage that external experts can be brought in for commercial due diligence if required. This allows the expertise in the team to be further increased and expert interviews can be used to further validate or discard assessments and findings.

 

  • Entrepreneurial mindset

In order to add further experience to the purely analytical part of a commercial due diligence, an entrepreneurial background of the advisors is useful. Previous activities as an independent entrepreneur or activities in a company in the digital economy are enormously helpful in order to be able to better assess companies and their organisation and processes. In addition, these consultants know the everyday life in companies and can better assess which ambitions and changes are realistic. These empirical values therefore help overall to make better assessments regarding the development and future forecast of companies and to meet the potential target at eye level.

 

4. Summary and outlook

Activity in the private equity market is currently at an all-time high in Europe and a decline is not expected due to cheap money and the lack of alternatives. This increases the need of private equity houses for due diligence services and confronts them with the question of what type of advisors to choose.

Should aconsultancy be chosen, which is characterised by standardisation and low costs, or a consultancy which focuses on a highly individual and high-quality approach at higher costs?

Due to standardisation and a lack of industry knowledge, low-cost consultancies are usually unable to achieve the same quality and granularity in their analyses and assessments as consultancies with a high level of industry knowledge. This creates the risk that important strengths and weaknesses of the companies are not recognized and that incorrect forecasts are derived. When selecting consultants, the most important things to look for are a deep understanding of the digital economy, strategic foresight regarding e-commerce and digitization, strong networking among consultants in the digital economy, and an entrepreneurial mindset. The best way to recognize these skills is through the profiles of the consultants in the offer, the topicality of the content of the companies on their own homepage or Social Media platforms such as LinkedIn or the presence of the consultants in relevant media and their publications.

We look forward to your opinion, a joint exchange and exciting discussions – feel free to contact us via email, LinkedIn or even by phone.

For further recommendations and dedicated strategies around the topicsE-commerce, due diligence and Transformation we are always happy to assist you.

Your FOSTEC & Company Team

 

 

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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.

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Markus Fost

Managing Partner
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.

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