The deal-making boom of 2021, which drove both deal numbers and valuations to new highs, faced significant disruption in the latter half of 2022. For the year, the total value of deals fell 37%. Worldwide, private capital is sitting on as much as $3.4 trillion of “dry powder”—assets under management that have not yet been invested. Executing deals has become increasingly difficult due to disruption in geopolitics, supply chain, and capital markets, and has contributed to growing mismatch between the expectations of buyers and sellers. Finding financing has become among the most notable challenges. Heading into 2023, it’s clear that closing deals and delivering value has become trickier than ever.
The basic deal thesis is also evolving. In the high-growth market coming out of COVID, the value of many deals was predicated on reliably rising sales. As a result, the diligence process gave heavy emphasis to commercial value creation opportunities, often with a reduced focus on the operational and technology infrastructure needed to support it. In a number of high-profile cases, the unanticipated risks associated with a business’ operations, technology, governance, and controls drove negative outcomes.
Going into 2023, buyers should approach due diligence differently. To create greater certainty around realization of deal value, they must integrate operational, commercial and technology levers in the diligence process—and they must do so in a way that maps directly onto robust integrated post-close value capture plans and actions – while understanding the potential risks and mitigation.
The diligence report itself and pre-close “road show” need to be very different. The broader set of co-investors and lenders needed to get deals closed are now demanding rich insights into the deal thesis, value creation plans, and execution risks. They want to see that the operations are sound, the commercial story is well grounded, and the technology roadmap is clear. These must be told as a single, consistent story that is compelling to a broad range of stakeholders (including sellers) with highly varied investment requirements and potentially conflicting objectives.
Why should dealmakers think about integrated value-led due diligence?
First, as buyers are looking to wider and more diverse sources of funding, they need to understand and address those investors’ often-differing requirements and value propositions. Addressing these diverse perspectives is critical in a challenging market. An integrated approach to due diligence can create common ground about the drivers of value and how to both realize it and protect it.
Second, businesses are facing new challenges from an unpredictable, volatile economy, where past performance is no longer a meaningful indicator of future success. Higher inflation, slower top-line growth, increasing global supply chain complexity, greater integration of commercial relationships, operations, and technology and expensive capital—each and all of these put enormous pressure on the critical first 12-24 months of ownership. Sophisticated buyers must place increased scrutiny and control on the levers to drive EBITDA and cash during this period with evidence of a rapid and robust plan to execute on value creation initiatives.
Understanding and underwriting a deal requires a clear, consistent view of near-term EBITDA and cash performance levers, based not on isolated assessments of the external market and light-touch assessments of the operations and cost base, but by a deeply integrated diligence of the value thesis for the deal and the asset’s commercial activities, operational infrastructure, operating model, and technology enablement to support this. An integrated, value-led due diligence must also consider the potential headwinds and risks that can derail a deal thesis and the mitigation plans to address these.
The third reason: speed. Approaching due diligence with integration in mind allows buyers to realize value faster. With lower deal flow and significant dry powder in private markets, buyers—private equity or strategic—face increased competition, which intensifies the pressure to compress “award/offer to close” timelines. The period between signing and closing can be crucial to translating the findings of the due diligence activities into value creation action plans and further examining red flags identified during earlier phases. Minimizing friction and hand-offs during this phase is a key to success in capturing the value as early as possible once the new owners are in place.
How should buyers approach integrated value-led due diligence? Four things make the difference:
- Understand the importance of a value-led lens to integrating operational and technology value creation levers with the drivers of commercial value. Separate the diligence of commercial value levers (pricing, product, go-to-market, customer success) from the operating model, operations, and technologies required to pull those levers risks creating myopic views. The strategic and commercial teams for one asset we advised on, for example, had forecast 14% revenue growth without considering that the target was already running its plants at full capacity and would need additional capital to realize the commercial plan.
- Assemble a team with experienced and senior people, who understand how to execute value creation plans and can support you in engaging the capital markets. Good value-led diligence is not a box-ticking exercise. As the demands of increasingly diverse funding stakeholders add more complex perspectives, having a senior, experienced team to identify and articulate how value will be realized will be critical to successful deal making in 2023 and beyond. Co-investors need confidence in both the soundness of the deal thesis and the ability of the team in place to execute and rapidly deliver.
- Focus on value creation, but don’t discount risk mitigation. 2023 is set to be a highly complex economic environment in which to do business. Even the most robust plan can be buffeted by unforeseen headwinds. An integrated value-led diligence will help teams anticipate risks and identify the ways to mitigate and manage them.
- Design a diligence process that operates seamlessly - from signing to closing and beyond. When diligence is done right - and transitioned to a value capture plan - it’s a process, not a project. Too often, the team required to realize value creation plan is not involved early enough in the deal process. The diligence team should ideally be working with management to stand up the programs required to drive value creation initiatives prioritized during diligence. An AlixPartners team advising one multibillion-dollar telecommunications company identified more than $1 billion in savings—and captured 40% of that within the first year. Getting that kind of early return demands a willingness to invest in the continuity of value-led diligence outputs that can be seamlessly transitioned into the sign-to-close planning and ultimately an actionable day 1 program to realize value.
In the 2023 M&A market, focusing on these four key elements has never been more essential.
A checklist for more effective diligence:
Start early in the right places. Starting early can get you a smarter deal thesis and identify opportunities others miss.
- Synthesize diligence around value drivers. Integrating the operational and technological drivers of value creation with commercial levers will provide much greater certainty during diligence on the deal’s true value thesis and opportunity.
- Look for sources of value, as well as areas of risk. Troubleshooting is only the beginning. An experienced diligence team can find significant margin and market expansion opportunities and understand where the risks to value lie.
- Use an experienced, operations-minded team. The ideal team combines industry, operations, and value capture implementation expertise.
- Take a tested, hypothesis led approach to value creation. Value creation derived from benchmarks might or might not be realized; those derived from specific insights can become turnkey initiatives with an action plan.
- Make sure your team can pivot to execution—and move fast. You will never have as much momentum as you do on the day the deal closes. Capture as much value as quickly as possible. Speed to execution should be job one.
- Minimize hand-offs. The best operational diligence connects seamlessly to integration. Every hand-off costs time and puts focus at risk.