Doing Diligence Right: How To Protect And Drive Deal Value In Disrupted M&A Markets – Contracts and Commercial Law

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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

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

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

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:

  1. 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.

  2. 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.

  3. Focus on value creation, but don’t discount risk
    . 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.

  4. 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

  • Look for sources of value, as well as areas of
    Troubleshooting is only the beginning. An
    experienced diligence team can find significant margin and market
    expansion opportunities and understand where the risks to value

  • 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
    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.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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