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The Due Diligence Objective In our February 2018 blog post we noted that every successful acquisition starts with the identification of the deal rationale, or the “why” of the deal. This rationale should drive all subsequent activities including the approach to due diligence. First solidifying the business objective, and subsequently analyzing the target to assess whether it will help achieve that objective, can prevent missteps such as the “Double Trouble” example from our March 2018 post. Our goal, therefore, is to evaluate the target company to determine whether acquiring this company addresses our deal rationale objectives, while simultaneously getting comfortable that the risks are not sufficient to erode the overall value proposition. Conduct Due Diligence Research Most integration professionals will have a standard due diligence “checklist” of items that the buyer would like the seller to provide for evaluation. Mine is just under 30 pages in length, single-spaced! On a large deal I will usually get to submit less than half of the questions on my list, and for smaller deals I might be able to submit only 15-20%. So, one critical early step is to pare the list of inquires down to something that is manageable but still provides sufficient information to evaluate the target. Spending a few hours on research is one way to effectively whittle down the checklist. You would be surprised how much information is available via:
Buyers can be reluctant to invest the time in this research; however, I find it often yields a treasure trove of information that can be used to answer some diligence questions preemptively, and certainly helps to focus the diligence checklist! If you don’t have time to do the research yourself, bring in a temp or an intern. The work isn’t difficult and it is well worth doing before you commence with decisions about designing due diligence scope. I once found information on an industry blog about a well-known defect in a target’s primary product, which had not previously been apparent from any of the provided documents, and which had a material impact on some of the valuation assumptions we were using. Bottom line- take the time to dig- it’s worth it. Use PESTLE to Further Refine the Diligence Plan After compiling research, a useful starting point for scoping due diligence is to revisit some basic strategic frameworks. If you’ve been following the method we discuss in this blog you will already have used Porter’s 5 Forces and SWOT in your initial target identification. For diligence purposes the PESTLE (sometimes spelled PESTEL) framework is useful. PESTLE is an acronym:
Political risks usually take the form of potential changes in regulations or policies. Health care and social media are good examples of industries facing political risks. Economic risks are pertinent to businesses with commodities exposure, heavy reliance on discretionary consumer spending, foreign currencies, or other key economic factors. For example, these are significant considerations when I do deals in the international oil, gas, mining, or food/beverage industries. Social/cultural risks relate to the potential for loss of goodwill, litigation, or eventual political exposure due to negative public perception of the company or industry. I’ve seen this in media and entertainment with regards to violent content, and social media is definitely facing scrutiny here as well, as are processed food companies. Technological risks arise due to the disruption of existing businesses by emerging technologies. Who would have imagined 10 years ago that we might have self-driving vehicles? As robotics and automation improve, most industries will need to consider technological disruption to some degree. Legal risk refers to current or potential litigation risks. These aren’t always a bad idea. I’ve seen bargain purchases of companies that were facing litigation exposure, but risks should be thoroughly investigated in diligence so that valuation can be properly adjusted. Environmental risks are critical in resources businesses like oil, gas, timber, and mining; however, depending on the political environment any company can incur substantial changes to their cost structure due to environmental regulations. Determine Participants for Due Diligence There are conflicting schools of thought when it comes to participants for due diligence. Strategy and Legal experts seem to prefer as few participants as possible, while Finance and Operations want to see broader representation. Here again the deal rationale and its corresponding TOM can offer guidance. If the TOM calls for minimal integration, you should need fewer diligence participants. Where the TOM calls for medium to full integration, you should consider putting a larger team in place. Regardless, the best results are produced when the diligence team is broad enough to validate TOM assumptions, and to analyze the deal in terms of the deal rationale. This is the one reason I advocate for the use of code names, and for a thorough onboarding process for diligence resources. Keep in mind that work done to eliminate a deal from consideration is not “wasted effort”, it’s production! Rationalizing investment choices is a legitimate activity, regardless of the go or no-go decision resulting from the analysis. Should the decision be to move ahead with the deal, a properly organized and executed diligence process generates a significant portion of the integration plan and budget, thus saving time later in the process. Appropriate participants will vary by deal, but some general guidelines are as follows:
Note that the recommended participation, even for minimum integration, still extends across quite a few areas. We’ve spoken before about the importance of including Tax to ensure that the deal is structured in the most efficient way possible. Legal and HR are required to ensure compliance. Finance will be key to analyzing deal value, providing modeling inputs, and establishing synergy measures. The Integration Lead will be responsible for overseeing realization of the chosen TOM and the corresponding synergies.
Recap Take the time to research publicly available information on your target. Apply the results of your research using some standard strategic frameworks, incorporating all this information into the on-boarding materials for your diligence participants. Let the TOM inform the composition of your diligence team, but don’t hesitate to include more resources- the broader participation should pay off in terms of better results.
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