Top Diligence Questions To Prepare For A Recession

Potentially turbulent times are ahead. Will your diligence target company sink, stay afloat, or thrive? Data analytics can shed light on the top diligence questions to prepare for a recession or downturn.


Diligence Questions For A Recession

With a possible downturn looming, our clients come with a slightly different perspective during diligence. Fundamentally their core business questions are the same: what are the drivers of company performance, are KPIs like customer quality ticking up or down, and so forth.


However, lately client focus has also been on revenue sustainability, marketing optimization, and other ways to de-risk deals and create value in the face of a market downturn. In essence, key data-driven diligence questions are now re-centering around a company’s ability to grow sustainably and its opportunity to spend wisely.


Grow Sustainably

The first diligence question concerns the durability of revenue during a downturn. Analytics can review historical stability as a signal for revenue robustness. At one business services firm, we found that existing customers could be relied on for 90% of revenue annually. Even if the firm gained no new customers in a year, a large proportion of its revenue would still re-occur.


Identifying this core customer base can thus be key to sustaining revenue. At a DTC company, we found a group of loyal customers that purchased consistently year after year. Despite encroachment from competitors, this group sustained the company and could be relied on as a dependable future revenue stream.


Using data analytics to understand customer spending behavior can reveal potential revenue durability in volatile times. Data analytics can also shed light on cost optimization.


Spend Wisely

Intuition often suggests reducing spending during a recession. In one example, a DTC company saw higher customer acquisition costs due to greater competition for digital ad space during COVID. Using econometrics, the optimal marketing spend was found to be significantly below what the company was spending. Even though reducing that spend meant acquiring fewer customers, the loss in lifetime revenue was more than made up for by the savings. The resulting funds could be allocated to increased ROI efforts.


But cutting expenditures may not always be the right decision. Research has found that companies that reduced marketing spend during a recession bounced back more slowly compared to peers that sustained or even increased marketing spend. Whether this is causal or an example of reverse causality, it certainly raises issues for management teams to consider as well as test in the market. Especially in cases where the LTV:CAC ratio is high, raising marketing spend despite larger economic conditions can be the better long-term decision.


Key items for data in diligence

Diligence questions in preparation for a recession are not very different to regular diligence questions, but focus more on revenue durability and cost optimization opportunities. Large volume of data and advanced statistical techniques can help private equity deal teams gain insight when conducting due diligence during times of uncertainty.


Picture of Joseph Davin

Joseph Davin

Joseph Davin is Founder and Managing Partner of Davin AI. He was Head of Data Science at Two Six Capital and West Monroe Partners. He received his PhD in Marketing from Harvard Business School, is a Senior Fellow at Wharton Customer Analytics, and teaches at Cornell Tech.