For an Effective Due Diligence, Stay Focused 

Don’t let the cost of due diligence tempt you to skimp on understanding your acquisition.  Rather, ensure that the effort of your diligence is put into high value assessment with focus. 

Studies consistently show that between 70% and 90% of mergers and acquisitions fail to meet their initial objectives. Most of this pain can be avoided with effective diligence followed by practical post-acquisition planning.  Good diligence avoids failures by aligning the acquisition team around identifying significant business risk and creating actionable remediation plans.  

Buying a company is complex.  The seller is motivated to present their company in the best light possible, highlighting strengths and downplaying weaknesses. It is easy to believe that the best way to uncover these weaknesses is a diligence that reviews every aspect of your target in detail, but this is generally unnecessary and very costly.  Overly detailed diligences can also create too much information, making it easy to miss important elements.  An effective diligence focuses on identifying key risks and their implications, with investigations limited to those specific issues. This diligence approach also importantly controls acquisition costs. 

So how do you run your diligence to ensure that the money you spend improves the outcome of your acquisition? 

Keep your eye on the goal: Clearly agree upon the business objectives from the acquisition between your ownership and executive team before engagement.  Agree upon how you will measure success and have the deal team structure the negotiation with these objectives in mind.  As you negotiate and learn more about your acquisition, you may be tempted to change your objectives in an effort to close the deal.  Don’t change your objectives without agreement across your entire board and executive team and ensure that your negotiated deal supports changes in objectives.  Identify the key aspects of the acquired company that are required to meet these objectives and associate risks.  Keeping your diligence focused on the goal keeps diligence efforts contained to value. 

Leverage the entire deal team: All too often diligences are performed by functional groups in silos – marketing, finance, operations, facilities, IT, etc.  My experience has shown that the most critical aspects of an acquisition, and the ones most often missed, are cross functional.  Functional experts can still meet separately with target company functions, but reviewing findings as a group allows issues to be understood faster, with fewer meetings and in more detail. I recently reviewed a company where a weak order to cash process was causing significant cashflow problems and revenue leakage. The issue was most evident in the finance workstream, but the root causes weren’t understood until the deal team briefly discussed the issue and identified problems in order fulfillment and payment collections.  The combined team was able to understand root causes, and their needed fixes, much faster than the siloed teams.  

Frequently feed key diligence findings to the negotiation team: Due diligences often feel like mad scrambles to develop deal terms, working to beat out competing offers.  Many people work to assess the deal in many meetings, yielding many findings on the acquisition target. In the scramble to get a deal done, key acquisition findings are often not communicated to the negotiation team and therefore not reflected in offers.  Similarly, the deal team may receive too many diligence findings without a clear understanding of what may truly impact offer price or terms.   Have a process for identifying material issues found in diligence and clearly communicate them to those who are working the deal for maximum negotiation leverage.  This will result in most favorable deal pricing and terms. 

Create plans for the acquisition before you sign:  The best way to understand the impact of a negative diligence finding is to create a high-level plan to resolve the issue post-acquisition.  What resources will be required?  How quickly can it be addressed?  Who will be responsible for getting it done?  What is the impact on the business until it is resolved? You don’t need a task-level plan, but you do need enough detail to sort out required investment for inclusion in the  overall acquisition program.  Forcing this discipline before signing enables you to think through the issues that may jeopardize your deal goals. Focus on only material issues, minor issues, which should be resolved, can be worked out by your company areas as part of normal business operations. 

Focused due diligence in practice: Another recent diligence illustrates the value of diligence focus.  In this recent example, target growth projections relied on the target’s logistics ability to scale by a factor of five over two years.  However, IT assessment found that the primary logistics system was to lose support in one year and required replacement.  The deal’s growth goal allowed the deal team to understand the scope, scale and urgency of replacing the old logistics system, a multi-million dollar project that would impede business operations during implementation.  A high-level plan for addressing this problem was drafted and was communicated to the negotiating team as one of six negotiation issues to manage and resolve.  Because the negotiation team was focused on a short-list of value-impacting issues, and because they could clearly show the seller the value impact of these issues in the negotiation, they were able to get price and term concessions, providing funds in the deal to address the issues.   

Being clear about the desired outcomes of your acquisition, and leveraging the expertise that you have available is a powerful way to focus diligence work, reducing diligence cost and driving better deal outcomes.  It is also very important to use an experienced diligence team who can spot issues quickly.  Using these principles on your acquisition due diligence will yield better results and significantly better deal values. 

Charles Leinbach is an M&A and technology leader, having spent over 30 years helping companies grow through organic growth, M&A activities and Digital Transformation. Charles has worked for global firms such as Monitor Company, AlixPartners, C-bridge, and Hewlett Packard, and now is a Principal at Downeast Growth Consultants.  Charles has supported over 40 M&A transactions around the world. 

Downeast Growth Consultants is a firm that helps early-stage and mid-size companies grow to their potential through organic growth and acquisitions.  Downeast offers growth assessments, growth project implementations, acquisition diligence and post-sign acquisition services.  For more information please visit our website at www.downeastgrowth.com.   

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