At a glance
- Successful online businesses tend to combine online specialists with business strategists, but it is easy to be caught out by misleading terminology
- Digital due diligence should involve an assessment of the fiscal contribution of online
- There are ten "red flags" – areas that must be closely scrutinised if a GP wants success from an online business
You’re thinking of investing in an online business? Excellent news – but first let’s make sure you know what you’re buying into. In the first instance, an online business defined as one that organises its product, service, information and communications channels via the internet.
So your first question should be what kind of business is the target actually in? What would the assets or value be that your private equity firm is actually buying?
Confusion of terms
This may sound obvious, but it’s an important consideration because many investors (and business professionals) often confuse “e-commerce”, “online”, “technology” and “digital” businesses. In other words, they don’t necessarily know what they are buying until they are well into the detail of due diligence. There can be a lot of smoke and mirrors with these companies, so what initially looked like Google Mk.2 may turn out to be simply an entrepreneur, two geeks, a badly spelled brand and a business plan on the back of a fag packet.
A digital business, for example, might not have any technology in it at all: it could be a collective of people who specialise in digital communications, such as an online PR agency. From an investment perspective it’s vital to ensure your first step is understanding the business model of the potential target and what its assets are (whether people, technology, intellectual property, or a combination of some or all of these).
A successful online business, meanwhile, is one that has identified a gap in the internet market where there is significant potential for growth, economic or social change, and then organises itself to take full advantage. It combines “best of breed” online specialists – core competencies are digital marketing (especially search and social), data analytics and internet platform technicians – with “best of breed” business strategists and operations.
That means the first thing any investor should conduct is digital due diligence. This is complementary to traditional due diligence but requires specialist knowledge of digital marketing and technology practices, as well as an understanding of the strategic and operational opportunities and pitfalls that an online business may face.
First, the firm should commission an assessment of the fiscal contribution of online (i.e. the internet-based operations) to the actual and future growth potential of the target business, and an additional assessment of how competitive the business’s strategy and executional tactics are, vis-à-vis its competitors online. What is the size of the market online and what percentage share does the business have, both currently and prospectively? As you would ask of any investment target, what does it need to do to realise market domination?
In addition, there can be “red flags” – areas that private equity investors should interrogate closely if they want to be sure their potential targets are on the road to online business success. They include:
1. Quality of talent and talent management within the business – not just in terms of the employees’ online skills and specialisms but their ability to propel the business to success (i.e. their attitudinal/behavioural factors). There is a huge digital talent gap in the global market, so those businesses who invest in organic growth of their digital talent will gain ground. You should look at how the talent is nurtured, motivated, incentivised and rewarded to meet business targets. Do they have individual targets towards contribution of growth? How focused are they on beating the competition?
2. Culture – what is the pace of the business? How dynamic is it in terms of innovation and output?
3. Communications – look at how internal communications are managed using technology and Web 3.0 tools to facilitate collaboration, team-working and an open and honest environment. How does the business communicate with the market? What online communications channels are leveraged to have a direct and interactive dialogue with all business audiences – consumers, media, investors/the City?
4. Online brand equity – you should assess to what extent the business comes across as “one voice, one message” on the internet – across all its brand assets and communication. Track how well received the brand is by consumers. You can find out what they’re saying about the brand and product, and how the business is listening and responding – social networks are particularly useful here
5. Customer acquisition – examine how the business, and the sales and marketing channels, are organised in order to maximise new customer acquisition. Have specific volume and profit margin targets been set for individual online acquisition channels such as search and affiliates?
6. Customer experience and conversion – does the business have a resource dedicated to ensuring that the website is continually improved to increase conversion rate?
7. eCRM – analyse how effectively the business gathers data on its prospective and converted customers. You should look closely at its eCRM strategy to see, for example, how email is combined with social media engagement to drive recommendation and loyalty
8. Technology – find out if there is sufficient understanding of technology beyond “traditional IT”. For example, is the CTO or IT director motivated and incentivised around revenue growth? Is there sufficient and flexible resource to manage the day-to-day optimisation needs of the business – tweaks and enhancements to platform and website, installation of tracking and developing new technologies?
9. Operations – analyse how process-led the business is. You should find out what the performance-driven cycles of the business are and how regularly the sales and marketing teams report on performance
10. Strategy – critically, examine how the business plans itself around digital data-driven insights. How is the operation structured so that data insights can be mined, filtered, analysed and reported up to the management team to inform the broader business strategy?
With so many companies now operating in a multichannel environment, and the massive growth of purely online businesses, private equity firms are well aware that this is an area of high potential growth over the next five or ten years. They should also be aware that these online investments have specific demands and issues, and that these need to form part of the due diligence process to ensure ongoing success.
Amanda Davie is managing director of Reform.