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HOW SHOULD YOU DILIGENCE AND VALUE COMPANIES AMID FEARS OF A MARKET DOWNTURN?



For companies or investors looking to make acquisitions or investments โ€ฆ how should you diligence and value companies amid fears of a market downturn?


Here are three mental models weโ€™ve applied in recent client projects:


๐Ÿญ) ๐—ฆ๐˜๐˜‚๐—ฑ๐˜† ๐˜„๐—ต๐˜† ๐˜๐—ต๐—ฒ ๐—ง๐—ฎ๐—ฟ๐—ด๐—ฒ๐˜โ€™๐˜€ ๐—ฐ๐˜‚๐˜€๐˜๐—ผ๐—บ๐—ฒ๐—ฟ๐˜€ ๐—ฏ๐—ฒ๐—ฐ๐—ฎ๐—บ๐—ฒ ๐—ฐ๐˜‚๐˜€๐˜๐—ผ๐—บ๐—ฒ๐—ฟ๐˜€ ๐—ถ๐—ป ๐˜๐—ต๐—ฒ ๐—ณ๐—ถ๐—ฟ๐˜€๐˜ ๐—ฝ๐—น๐—ฎ๐—ฐ๐—ฒ. ๐—ง๐—ต๐—ฒ๐—ป ๐—ฒ๐˜…๐˜๐—ฟ๐—ฎ๐—ฝ๐—ผ๐—น๐—ฎ๐˜๐—ฒ ๐—ถ๐—ณ ๐˜๐—ต๐—ฒ ๐˜€๐—ฎ๐—บ๐—ฒ ๐—ฑ๐—ฟ๐—ถ๐˜ƒ๐—ฒ๐—ฟ๐˜€ ๐˜„๐—ถ๐—น๐—น ๐—ฐ๐—ผ๐—ป๐˜๐—ถ๐—ป๐˜‚๐—ฒ ๐˜๐—ผ ๐—ต๐—ผ๐—น๐—ฑ ๐—ถ๐—ณ ๐—ฐ๐˜‚๐˜€๐˜๐—ผ๐—บ๐—ฒ๐—ฟ๐˜€โ€™ ๐˜€๐—ฝ๐—ฒ๐—ป๐—ฑ๐—ถ๐—ป๐—ด ๐—ฏ๐—ฒ๐—ฐ๐—ผ๐—บ๐—ฒ๐˜€ ๐—ฐ๐—ผ๐—ป๐˜€๐˜๐—ฟ๐—ฎ๐—ถ๐—ป๐—ฒ๐—ฑ

Buying patterns driven by regulation and non-discretionary spend (e.g. rent, food staples, insurance, healthcare) are stickier.


For example, one Target that we evaluated in the real estate industry has a wall of patents around their technology, and nearly all the revenue was driven by town safety mandates .. and we modeled the demand drivers to continue.


Spending patterns driven by discretionary or non-essential spend could get squeezed (e.g. restaurant eating, leisure products or services including travel, expensive technology)


๐Ÿฎ) ๐—™๐—ผ๐—ฟ ๐—•๐Ÿฎ๐—• ๐—ฐ๐—ผ๐—บ๐—ฝ๐—ฎ๐—ป๐—ถ๐—ฒ๐˜€, ๐˜๐—ฟ๐˜† ๐˜๐—ผ ๐—ฎ๐—ฝ๐—ฝ๐—น๐˜† ๐˜๐—ต๐—ฒ ๐—ฎ๐—ฏ๐—ผ๐˜ƒ๐—ฒ ๐—ฐ๐—ผ๐—ป๐—ฐ๐—ฒ๐—ฝ๐˜ ๐—ผ๐—ป๐—ฒ ๐—ผ๐—ฟ ๐˜๐˜„๐—ผ ๐—น๐—ฒ๐˜ƒ๐—ฒ๐—น๐˜€ ๐—ฑ๐—ฒ๐—ฒ๐—ฝ๐—ฒ๐—ฟ

For example, we recently valued a Target (โ€œCompany Aโ€) that provides video technology to monitor the public areas of high end hotels (โ€œCompany Bโ€).


Reduced high-end travel spending negatively impacts Company B, which in turn negatively impacts the revenues of the Target, Company A


๐Ÿฏ) ๐—˜๐˜ƒ๐—ฎ๐—น๐˜‚๐—ฎ๐˜๐—ฒ ๐—ถ๐—ณ ๐˜๐—ต๐—ฒ ๐—ง๐—ฎ๐—ฟ๐—ด๐—ฒ๐˜ ๐—ฐ๐—ฎ๐—ป ๐˜๐—ฎ๐—ธ๐—ฒ ๐—บ๐—ฎ๐—ฟ๐—ธ๐—ฒ๐˜ ๐˜€๐—ต๐—ฎ๐—ฟ๐—ฒ ๐—ณ๐—ฟ๐—ผ๐—บ ๐—ฐ๐—ผ๐—บ๐—ฝ๐—ฒ๐˜๐—ถ๐˜๐—ถ๐—ผ๐—ป ๐—ผ๐—ฟ ๐—ด๐—ฎ๐—ถ๐—ป ๐—ป๐—ฒ๐˜„ ๐—ฐ๐˜‚๐˜€๐˜๐—ผ๐—บ๐—ฒ๐—ฟ๐˜€ ๐—ฑ๐˜‚๐—ฒ ๐˜๐—ผ ๐—ฐ๐—ต๐—ฎ๐—ป๐—ด๐—ถ๐—ป๐—ด ๐—ฏ๐—ฒ๐—ต๐—ฎ๐˜ƒ๐—ถ๐—ผ๐—ฟ๐˜€

Reduced customer spending is not always bad, it depends on the specific investment.


A Target that has already demonstrated strong product-market fit can thrive in an environment where its competition is less mature or where the Acquirer / Investor can fund operations enough to give the Target some buffer


A recent client was evaluating a technology acquisition in the education industry (and the Target in this case passed both the tests #1 and #2 above).


Further, the Acquirer was prepared to fund the Targetโ€™s sales and operations for ~2 years, even if the Target generated minimal cash flows, to focus on capturing key new accounts. This a war chest that the Targetโ€™s competition does not have.


Only time will tell us how accurate our assumptions were, but our business case, while still conservative, reflected this as a growth driver.

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