Compared to its importance in post-deal value creation and frequency of discussion around the board table, Customer Acquisition rarely receives much explicit due diligence (DD) pre-deal. As a topic, it will, of course, be discussed frequently by Management and potential investors. But the emphasis will typically be to appraise Management’s key assumptions and decide on inputs for the investment case model, rather than a deeper analysis of opportunities and risks.
Commercial DD, which I have both written and commissioned many times, answers important questions about the size of the market opportunity for a target business, its competitive positioning and historical evolution, and might look at some of the underlying business drivers e.g., sales per rep and number of reps. However, there are rarely more than a handful of pages in a Commercial DD report that are dedicated to how sophisticated a business is in terms of customer acquisition and the resultant opportunities/risks.
This suggests that there is a case for more consistent use of Customer Acquisition DD. Weighted against this is the fact that the number of DD reports is ever increasing, and these are in general more about understanding risk to inform appetite/pricing for an investment than uncovering opportunities.
What I learned from my time as a partner in a Private Equity Fund is to position work on Customer Acquisition as a ‘future planning’ exercise as opposed to pure (risk-focused) DD. This can deliver outputs that are more usable by both investor and Management and be seen as a constructive exercise rather than a one-way interrogation as many other DD workstreams can seem from Management’s perspective.
There were times when I was working alongside a deal team when an understanding of the customer acquisition opportunity was transformative to their appetite for a deal e.g., uncovering incredibly attractive unit economics that a Management team didn’t understand, or because we identified the potential for faster growth based on understanding the online competitive landscape and search volume trends. Other times it wasn’t as influential as value creation was more likely to be driven by M&A, but Management still found the work helpful, and it helped to ‘convert’ them to wanting to partner with us.
What does Customer Acquisition Due Diligence include?
The scope of Customer Acquisition Due Diligence is likely to vary based on the sector, business model, and current go-to-market approach of a target business, but will typically include:
An assessment of the go-to-market strategy – is there a clear strategy, is there Management alignment behind it, and how well this is put into practice? Specific topics can include:
Target customers / Ideal client profile
Proposition – what problem are we solving for our customers
Marketing channels used to generate demand.
Sales model e.g., online conversion, inside sales, enterprise sales etc.
An assessment of the operational platform across marketing & sales –
Roles, responsibilities, and org structure,
Data – in particular the measurement of marketing effectiveness and attribution
Use of tech tools to run the business and serve customers.
Processes / ways of working, including the use of automation.
Effective use of third parties
An understanding of where Management sees the opportunities and risks related to Customer Acquisition
A robust view on the starting unit economics, specifically the LTV:CPA ratio – can we afford to spend more per acquired customer, do we have a leaky bucket problem (i.e., high churn)? This is rarely something that will exist even if a superficial analysis has been undertaken as part of the investment process.
‘Flow’ market data vs ‘stock’ – it is important to understand the target’s share of clients who are looking to purchase e.g., in any given year, not just their overall share of the market as would be included in the Commercial DD. One approach to this for businesses selling online is to complete a search headroom analysis, perhaps supplemented with primary research.
Competitor approach to customer acquisition – sophisticated competitors will translate to a higher cost of accelerating customer acquisition.
Overall, we are looking at how well the target business has created / understands its own growth flywheel and what the potential is to get this moving faster. In a mid-sized, growing business there will be many areas that could be developed further, but do the Management team focus on the areas that will move the needle fastest? Are they willing to try new things but rigorous in understanding what is working/not working?
How can you make Customer Acquisition Due Diligence worthwhile?
This sort of work should always come out with a small number of high impact recommendations – sometimes on the strategy, sometimes on the platform, sometimes on the people. I’d suggest forcing that list to be small to surface those opportunities that could play the most significant role in value creation. These outputs should be fully quantified to make them suitable to include in an investment case model – including relevant metrics such as the number of new customers, revenue, margins, acquisition costs, team costs etc.
Concluding that there aren’t any straightforward ways to accelerate customer acquisition is also a very valuable finding. I learned early in my time as an investor that sometimes there could be theoretical scope for improvement but that was unlikely to create much value – either because it was too stretching for the Management team, or because other value creation levers such as M&A were simply a better fit (several months trying to drive online lead gen in a very traditional telecoms business was a real learning curve).
A lot of the value from Customer Acquisition DD comes from pattern recognition. Where assessing the current approach of a target business, I rely on a picture built over time of what the best performing, comparable businesses had achieved so can make a relative judgement. I always seek to leverage the knowledge of others who have direct operating experience in a particular market e.g., to sense-check specific metrics or business practices, from the investor’s existing portfolio, my network or using an expert network.
As well as supporting the ‘conversion’ of the Management team, I also found that by approaching the work as a ‘future focused’ exercise, it is sometimes possible to access data that other potential acquirers may not have asked for. I try to offer to share findings with a target Management team whether the deal happens or not as a quid pro quo. Even a modest information advantage in a competitive auction process is worth having!
Perhaps unsurprisingly, I think there is enough evidence that Customer Acquisition Due Diligence can play a valuable role in the investment process, whether led by an in-house value creation team or by a third party – but its value is multiplied if it is positioned as growth/future focused. I probably wouldn’t even call it Due Diligence! A good piece of work up-front can be a great foundation to kick-start value creation post-deal.
If you’d like to discuss how you can approach Customer Acquisition Due Diligence, please Contact Me.
All views expressed in this post are the author's own and should not be relied upon for any reason. Clearly.