Digital diligence: New leaf for financial investors

PE investors (and public market investors as well) typically take a series of considerations into account before making an investment – accounting DD (Due Diligence), Legal DD, Commercial DD, Forensics (on the promoters or key management personnel) and in some cases, even a Technical DD. Each of these DDs is aimed at uncovering and guarding against different risks. And potentially, also uncover interesting value creation opportunities.

As businesses and the environment in which they operate change, the investment approaches need to change as well. It should not be surprising that Limited Partners (LPs) will start evaluating General Partners (GPs) and fund managers for their competence to assess the risk and opportunities presented by this technology-led business environment.

We recently did a Digital DD and to say the least, it was an eye-opening and refreshing experience for the fund (and, to the potential investee company). The investor and the company spoke Digital but did not envisage the depth to which this aspect of the business could be diligence.

"The ability of the investee company to succeed in the new digital environment could completely change the investment thesis for a fund. And, in many cases, this is important to cover for capital protection risk due to any potential threats from business model disruption."

We recommend every fund or financial investor (or even strategic investor) to conduct a Digital Due Diligence and ask the relevant questions among the following list of the ten most important questions.

• What customer need does the Target address? Can a new technology also address it equally or better in the next 5-7 years? Can a new business model change the way the product/service is consumed?
• If yes, how easy will it be for the Target to also lead the pack on the changing paradigm?
• What ripple effects will new technology or consumption model have on the business – working capital, channel/trade, supply chain, manufacturing, …?
• What is the influence and ‘share of sales’ of the digital channels? How is this expected to evolve? With this evolution, how do customer choice and underlying distribution economics change for the Target?
• Technologically, how sound are the Target’s Digital plans – Analytics, Social media, Customer engagement and grievance redressal on the digital channels, etc? Is Target winning the ‘Digital war’ in its addressable market?
• How can Target tap the digital supply and fulfillment channels? What resources, organization and infrastructure will it need?
• What is the spend on Digital (and Technology Enablement) to date? For Target to compete effectively, how much more investment needs to be budgeted?
• (If the Target has robust systems) What additional insights on pricing power, customer acquisition, customer retention/loyalty/churn, operational effectiveness, etc can be extracted during the DD phase?
• What is the risk of disruption from emerging technologies – blockchain, VR/AR, AI/ML, …? What are the unique value creation opportunities for the Target?
• How can Target use technology to lower its Cost of Revenue (CoR)? What is the upside of doing this well?

Contact us for the Digital DD before your next investment.

Authored by (at the time of writing):

Madhur Singhal, Leader, Financial Investors Group Practice

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