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A Better Approach to Due Diligence Investment Criteria

As economic activity begins to return to somewhat normal levels of growth, private equity firms (“PE firms”) will have the opportunity to play a key role in business recovery. Throughout 2020, PE firms helped companies manage inventory, build up their cash reserves, support management teams, and build digital capabilities. With PE firms now having the ability to take a step back and continue to balance their portfolio, they will need to increase their focus on the continuing shift in consumer products trends. Clarkston is sharing key considerations to ponder during the due diligence investment criteria process.

Due Diligence Investment Criteria

With U.S. ecommerce sales soaring to a record of 44.4% in Q2 and 37% in Q3 of 2020, organizations are feeling the pressure to ensure they have enough inventory to meet consumer demand. With PE firms continuing to search for targets in a constrained environment, analyzing their eCommerce strategy and capabilities, as well as their supply chain resilience is important during the market scan and due diligence phase.

eCommerce Strategy

With the rapid growth of consumers shifting to online, PE firms will need to understand the potential target’s eCommerce strategy and capabilities.

As new eCommerce trends come out for 2021, PE firms will need to evaluate the target’s eCommerce maturity and then compare to its competitors. A lack of visibility or access to data and technology capabilities may inhibit sales growth in a specific eCommerce channel. In the CPG space, close to 6 in 10 respondents said they hesitate to buy online because they don’t know if an item will fit.

With direct-to-consumer (DTC) expected to grow 19.2% in 2021 and less foot traffic in physical stores, target’s will need to start incorporating DTC into their model if they haven’t already. The target company will have the opportunity to appeal to technology focused consumers and retain the ones they already have. With different DTC opportunities available, PE firms will need to understand the target’s plan to either acquire DTC specific companies or create a DTC strategy internally, and how this will play into their overall eCommerce strategy.

Being able to accurately measure and continually focus on the target’s eCommerce strategy can recognize areas of growth potential, missed opportunities, and mitigate risks.

eCommerce Questions to Consider in the Due Diligence Investment Criteria Process

  1. Where are the consumers coming from? Is each new customer profitable on the first purchase, and if not, when is the moment that they become profitable for the target company?
  2. Is there a strong eCommerce presence at the company or will a new strategy and team need to be developed?
  3. How does their eCommerce strategy compare to their competitors? Are they focusing on the right channels?

Supply Chain Resilience

As COVID-19 continues to disrupt the market, and CPG companies see robust demand for its products, PE firms will need to ensure CPG management teams have resilient processes in place within their supply chains.

With 80% of shoppers wanting same-day delivery, 61% want their packages even faster (within 1-3 hours) of placing an order. PE firms will need to assess if the target company has the inventory to do this and if they have ability to relay the customer information quick enough to Supply Chain.

Target companies should encourage risk-taking and motivate through failure. As they navigate throughout disruption, private equity firms can assess and analyze what worked well for them and what didn’t throughout the new ideas and processes that were tried.

As more companies start to pour money into their supply chain, they will need to ensure they are allocating properly. We have seen well-known companies make large investments in supply chain in the recent months. Peloton just announced it will be investing more than $100 million in air freight and expedited ocean freight over the next six months to help the speed of deliveries. Clorox also announced that they will be aggressively investing to expand capacity and bring on new suppliers to meet consumer demand.

An area that can have a big impact in their supply chain resilience and strategy, is investing and developing their analytical tools and capabilities. Having access to high quality and real-time supply chain data is critical for effective decision making in today’s environment. With the correct analytical capabilities and tools in place, target companies can conduct scenarios and models to assess inventory constraints, supplier risk management, and optimization trends. With this knowledge, not only will they understand their business more, but be able to prepare for the next disruption.

Supply Chain Questions to Consider in the Due Diligence Investment Criteria Process

  1. What policies and procedures are in place to safeguard against risk and how well are they known and implemented in reality?
  2. What areas of supply chain is the target focusing on amidst the crisis (i.e. raw materials, manufacturing, packaging, etc.)? Is the focus in the right place?
  3. What capabilities and processes is the target company investing in? Has this helped or hindered their supply chain resilience?

Historical financial performance continues to be an important factor when evaluating a potential target acquisition, but the change in consumer preferences towards ecommerce and DTC, coupled with supply chain volatility, suggest that PE investors must go beyond traditional financial due diligence; a consulting partner with deep industry expertise can provide the best information through multiple sub-sectors across the CPG industry to give PE firms that competitive advantage and ensure continuous deal flow.

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Tags: M&A, Strategy, Strategy & Innovation