Simplifying the Due Diligence Process: A Practical Guide

27 January 2021, by Niel Dalrymple

Assessment of business plans, corporate acquisitions or disposals and refinancing will all require due diligence investigations to confirm the facts being represented in the matter under consideration. This will require a tool or series of tools which allow an independent audit of the information being presented so that it may be confirmed in both hard factual and reasonable projection terms.

The history of directorships and the inter-relatedness of companies need to be confirmed so that the question of who is being dealt with is covered. It can also be very illuminating to view the other directorships and shareholdings an individual has. Following the links by director to other companies where the same individual is also a director and following parent subsidiary holdings can often reveal unexpected interrelationships and cross holdings across competitors and sectors. The performance of these related companies is also often instructive.

Analysis of the sector the company is a part of is another key component of due diligence. Industry rankings of turnover and profitability will for example quickly show if claims made in prospectuses stand up. It is very easy to say “we are number 1” in the sector for example but the appropriate industry sector report will confirm or refute this very easily. Market share claims and the size of the market served should be checked from the figures available in a suitable sector report.

Often it is best to refine a listing from a sector report and the analysis is best completed using a shortlist of actual competitors rather than a listing based on SIC classification. The focus of the averages will be dependent on the group of companies used to calculate the benchmarks and as usual it is the same old story : rubbish in rubbish out. In other words the closer the competitors are defined and selected the more useful the comparative analysis. Trends and averages for the relevant sector are a key indicator of future prospects and should be used to inform the investigation – it is very much better if there is knowledge of just what is being averaged to produce these benchmarks when relying on them in this way.

This is true in all the sectors relevant to the firms so a thorough analysis might involve using a model from Micheal Porter looking at buyers, suppliers, substitutes, new entrants as well as the competitors. The power of Porter’s model is that it offers a strategic analysis of the market and goes to the value of the proposition. At the very least it would be sensible to compare the assumptions made in the projections being investigated with what has historically been achieved by well managed firms in the sector. It is perhaps unsurprising that accounts can be manipulated in the short term by deferring costs and pulling forward revenues for example. This can usually be spotted with a cash flow analysis. It would also be clear that ratios from the firm diverged from industry average benchmarks which might be expected.

A good, tightly defined grouping of firms will also provide the most useful ratios and trends for the relevant sub-sector within an industry. So for example an overall industry report might show unspectacular trends for some 600 firms operational in that sector. However, focusing on the 15 or 20 relevant most similar competitors either by size or product or geography for example there might be very interesting trends which can be verified. Within any sector of 600 firms there will be likely to be firms growing, stagnating and declining so the facility to focus more exactly will produce a much clearer picture of the potential.

Conclusion

A tool such as USP Data which contains all the live Companies House data linked up to allow directorships and ownership of firms together with the focused industry averages covering all UK sectors will be very helpful for Due Diligence checks. The particular strength of USP is the custom reporting facility which allows the focus on relevant sub-groups within any sector grouping with the associated rankings and averages of relative performance.

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