We generally recommend taking between 30 and 60 days to complete due diligence. We find this is enough time to complete a thorough evaluation of the business without letting the process drag on.

Due diligence will include onsite visits with your internal team and your external team of lawyers, accountants, and your third party M&A advisor. Your internal team should include more than just your CFO; we recommend involving your functional leaders from sales, marketing, and operations in this process because they will be in charge of running those functional areas once you complete the acquisition. Involve these functional leaders as early as possible so they can start learning about the business that’s being acquired and not only look for issues but also identify opportunities where you can realize the value of the acquisition.

In addition to onsite visits, you also have data requests that are sent out the acquisition prospect, asking for information about the company. We try to make this process a bit more interactive than a simple checklist by having a conversation around what is important to the business. Information is typically shared in a virtual data room which keeps the files secure and ensures only approved viewers access the documents.

One important thing to remember is that you can never completely eliminate risk, no matter how thorough you are during due diligence. We have a saying “Due diligence will go on forever…if you let it!” At some point you have to call the question and decide if you’ll pursue the deal or not. You’ll never uncover 100% of the issues during due diligence, but that’s why you have attorneys draft reps and warranties that can protect you if there are things found out after the deal. On the other hand, you’ll never uncover 100% (or any) of the opportunities by just evaluating the company. You will have to execute the acquisition in order to realize the benefits.

Photo credit: Craig Sunter via Flickr cc

Yahoo says the private information of at least 500 million has been compromised due to a cyber-attack in 2014. In the biggest security breach to date, hackers gained access to sensitive information including names, emails addresses, telephone numbers, birth dates, passwords, and security questions.

The security breach has ramifications not just for Yahoo and its users, but also for Verizon, which is currently in the process of acquiring Yahoo for $4.8 billion. Even though the cyberattack occurred in 2014, Verizon only found out about it last week. As a result of the hack, Verizon could possibly walk away from the deal or renegotiate the price.

The hack on Yahoo highlights the need for functional due diligence in order to identify all critical information that could potentially impact a deal. Leaders tend to focus on financial and legal data during due diligence, however failing to fully research other areas of the business, including cybersecurity, can be detrimental to your acquisition. You don’t want to find a “surprise” after the acquisition closes.

Functional Leaders Critical to Comprehensive Due Diligence

Functional due diligence is one of the best ways to ensure you are making decisions with the most complete data. This means incorporating leaders from each of the functional areas of your business – IT, sales, marketing, operations, accounting, finance – early on in the due diligence process. These leaders are involved in the day-to-day tasks of running the company and have a high-level of familiarity with their functional area. They are specialized experts who can spot problems, identify solutions, and ask appropriate questions that other executives may overlook.

It’s best to have each functional leader develop their own list of questions based on their experience working in the functional area of your business and the overall acquisition strategy. Next, have the functional leaders from your company meet with their respective leaders on the seller’s side to gather the necessary information. Once each functional leader has met with their counterpart, you can compile the individual lists into one comprehensive data set that covers all aspects of your business in thorough detail.

An addition to identifying risks and critical pieces of information, functional leaders can help develop and implement your integration plan. They will be able to anticipate specific integration challenges you may have and help develop solutions to avoid these pitfalls. Involving functional leaders in due diligence increases your chances of a successful acquisition.

Photo credit: Hades2k via Flickr cc

Culture is an important part of an organization, but it can be difficult to define. Unlike other areas, such as finance and operations, which have concrete metrics like revenue, EBITDA, and number of employees, quantitatively measuring culture can be challenging. Leaders often rely on their “gut” to understand another company’s culture, but this leaves an incomplete picture.

When pursuing mergers and acquisitions, fully understanding the seller’s organization, including its culture is critical to your success. Rather than relying on subjective impressions, we use the Cultural Assessment Tool to measure a company’s culture.

We look at about two dozen key areas and scrutinize how the company goes about doing business in each area. For example decision-making: Is it centralized or decentralized? It is fast or is slow? Is the company consensus-building or dictatorial? We use this tool in the first place to look within, and then to analyze a prospective acquisition. For implementation, we use an online questionnaire tool, such as SurveyMonkey, which is easy to deploy and delivers quick results.

The Cultural Assessment Tool

The Cultural Assessment Tool

How we apply the Cultural Assessment Tool depends on the size of the organization. We typically approach the process on four levels: shareholders, executives, managers, and employees in the organization. What we’re looking for is the perspective on the company’s culture at each level, so we can create a crosspollination of views across the organization. What often causes surprise is how differently people at various levels may view the same company culture.

For example, we worked with a company where the shareholders felt the culture was open and transparent, with flexible, nimble decision-making that nurtured innovation. The rank-and-file staff held a diametrically opposite view. They didn’t feel that the mission and operational plan were at all well communicated. In fact, they saw the culture as closed, dictatorial, and averse to consensus-building. It was almost as though we were talking about two different companies.

Using the Cultural Assessment Tool is one way to objectively measure and evaluate your own culture and the seller’s culture during due diligence.

Due diligence is an important step in the acquisition process that comes prior to closing a deal. Most people think about due diligence from a risk assessment standpoint or as a checklist of items that must be completed in order to move the deal forward.

Traditional reasons for undertaking due diligence include evaluating strengths and weaknesses of the seller’s organization, uncovering liabilities, and understanding risk. Ultimately the findings in due diligence are used to determine whether to proceed with the acquisition. Often, if liabilities are uncovered, buyers will try to renegotiate terms and get a lower price based on the findings.

While these traditional reasons for due diligence are useful and accurate, they can be too restrictive. By only focusing on the negatives in the organization you limit your thinking. Here are four ways to broaden your perspective and maximize the effectiveness of due diligence.

  1. Focus on opportunities – Instead of concentrating only on risks, think about how you create more value in the organization. For example, the seller may have a high cost for raw materials. Under the traditional approach to due diligence, you would flag this finding as a negative. However, this could be an opportunity for you to improve the company’s cash flow. As the buyer, you may be able to reduce cost of raw materials because you have a better purchase price due to the high volumes you are already buying.
  2. Plan for integration – Due diligence should not be used only to renegotiate terms or beat people up on price; it is really a tremendous opportunity to focus on integration and integration planning. Rather than focusing on yesterday, use it as an opportunity to guide your planning for the future.
  3. Identify star employees – We often ask the owner to identify key staff at their organization, but during due diligence you have a chance to do this for yourself. These star employees could contribute to the success of your organization for years to come.
  4. Craft a creative deal structure – If during due diligence, you find some problems with the organization, you don’t have to completely abandon the deal. Using a creative deal structure may allow you to get the deal done while isolating the liabilities. Instead of thinking about the deal as a binary decision of either 100% acquisition or nothing, consider how you can structure the deal for success. Perhaps a carve-out or minority interest would work in your situation.

Learn more in our upcoming webinar “A New Thinking on Due Diligence” on Thursday, May 26 at 1:00 PM ET.

A New Look at Due Diligence

Date: Thursday, May 25, 2016

Time: 1:00 PM EDT

Q: How often are you able to bring together both buyer and seller functional personnel during due diligence? Some sellers might be sensitive to confidentiality and not open to bringing their personnel into the fold.

A: When conducting due diligence, we advocate a functional approach, where leaders from the buyer’s organization meet with the seller’s. There are a number of advantages to this approach including paving the way for a much smoother integration once the deal is complete. However, sometimes you have cases where the seller, most often the sole owner of the company, wants to keep the deal quiet for as long as possible. Of course, it’s natural for a seller to feel this way because he or she does not want to alarm among the employees or generate unrest in the business for a deal that may or may not happen.

In cases like these, we have been most successful if the owner has at least a few trusted confidants that can act as proxies for some of the functional area leaders. In this case, you will not have an army of twenty functional leaders from your organization meet with the respective leaders on the seller’s side, but you may compile lists of questions that will be directed through a Vice President of Human Resources or a Vice President of Operations that the owner trusts. As much the owner wants to maintain confidentiality, we strongly advise he or she has at least one or two others from the organization involved in the transaction and due diligence.

If the owner wants to keep the acquisition completely under wraps, it is up to you to make a business decision of whether or not you want to continue pursuing M&A with the company. If you do continue down the path, you should have strong reps and warranties because you are not able to conduct accurate due diligence prior to the transaction closing. This way, there will be some recourse for you should you discover anything after the deal is announced and you have already taken over the company.

* This question was asked on our webinar “M&A: From LOI to Close.” Learn more about Capstone’s webinar series.

Q: “What if the buyer and seller functional leaders do not match? How do you coordinate the two sides?”

We take a functional approach to due diligence where we encourage your leaders from sales, marketing, finance, operations and other functional areas to meet with their respective leaders on the seller’s side. A functional approach ensures all important aspects are covered and explored during due diligence.

Due Diligence Buyer and Seller Interaction

Functional due diligence: Functional leaders from the buyer meet one-on-one with functional leaders from the seller during due diligence.

However, we often run into a situation where there are more functional leaders on the buyer’s side than on the seller’s because traditionally buyers tend to be larger than sellers. While you still want functional leaders from each side to meet, keep in mind you don’t want to overwhelm or intimidate the seller. I don’t mean take a soft or easy approach, but don’t have two or three of your functional leaders meeting with one leader from the seller’s side. It will feel like an ambush.

Identify which leader from your organization most closely aligns with their functional leader and pair them off one-on-one.  For example, while you may have accounting, HR and tax professionals, select only one of these leaders to meet with the individual performing all of these functions at the seller’s business. This approach will allow for effective communication between buyer and seller.

This question comes from our webinar “A New Thinking on Due Diligence.” Learn more about Capstone’s webinar series.

People are critical to the success of your company, and it’s no different in the business you are acquiring. But how can you go beyond the surface and find out what employees really think? It is doubtful employees will be completely open and honest when asked point blank, “Do you like your job?”

One of the best sources of information when conducting human resources due diligence are employee satisfaction surveys, especially those conducted by a third party. These surveys are not only telling about employees but also about management and the organization as a whole.

Review historical employee satisfaction survey results and look for key metrics and trends. It’s also wise to look at remediation – how has management responded to complaints in the past? This may provide insight into the management team, working styles and organizational culture.

When we’re consulting on integration, one metric my firm looks at is turnover. Is there high turnover within a department when benchmarked against this industry or the rest of the company? If so, why is this happening? In certain situations of unusually high turnover, we found that the department manager had been there forever but was an ogre to work with. Anyone with any intelligence who came into that department pretty much got run out because the manager felt threatened!

You can also discover “green buckets,” or opportunities, within the survey results. If employees are dissatisfied with their old computers, now may be the time for an upgrade. In one case we noticed employees had really old monitors. We found that the owner had upgraded the computers, but viewed upgrading the monitors or keyboards as unimportant. For our client, it was relatively inexpensive to purchase new monitors and employees were very happy with the upgrade. Look for these opportunities to form a positive relationship with your new employees.

An acquisition can cause anxiety for employees. Anything you do as the buyer that says “We care about you” will help reassure employees and make for a smoother integration process.

I’m often asked for a due diligence checklist by clients or acquirers who are anxious to make sure they’ve covered all their bases.

While there are plenty of due diligence checklists, I caution against using a list developed by someone else because it may not cover aspects that are important to your organization. Your questions will vary depending on your business and your strategy for acquisition.

I recommend using functional leaders from key areas of your organization such as sales and marketing, operations, IT and finance to develop a comprehensive list of questions that are specific to your company and your acquisition strategy. No one knows your company as well as the people who work there.

If you aren’t sure where to begin, I’ve listed a couple of key areas and example data points to help you get started.

  • Financial Information– This most often comes to mind when people think about due diligence. We typically ask for:
    • Audited financials
    • Pro-forma income statement, balance sheet and cash flow statement
    • Past five-year tax reports
    • Five-year projections
  • Customers and Suppliers – Request information on key customers and suppliers and any contracts that are in place.
  • Management – Don’t forget to gather information about the seller’s management, including personal references and a verification of personal history. What you may uncover by digging a little deeper may surprise you.  It’s much better to find any skeletons before closing the deal. On the other hand, you may also find some pleasant surprises and opportunities.
  • Product Literature – Ask for marketing literature such as sales brochures and promotional materials.
  • Other Information – We may ask sellers for company bylaws, articles of incorporation, board minutes and 401K plans.

Please note what I provided here is not complete. You should use these examples to develop a complete list with your acquisition team.

 

You can increase your chances for successful acquisition by using functional due diligence to evaluate a prospect. This means actively involving leaders of the key functions of your organization: functional leaders from sales and marketing, finance, operations, IT, etc.

There are several benefits to involving functional leaders in the due diligence process.  Each leader has a different perspective and can provide unique insights to help evaluate an acquisition target. That’s because each functional leader focused on a specific area has a deeper understanding of the day-to-day procedures and may point out unseen risks and opportunities.

In addition, involving functional leaders early on in the due diligence process leads to a much smoother integration once the deal is complete.

To learn more about functional due diligence, please join my webinar on “A New Look at Due Diligence” on July 24, 2014.

Due diligence is often seen in purely negative terms, as a way to avoid pitfalls or find “hidden skeletons”. In this webinar you will learn how to use due diligence positively, to maximize the opportunity for a successful acquisition.

After this webinar you will be able to:

  • Organize due diligence to maximize efficiency and get the information you need to move the deal forward.
  • Know what items to look for by key functional areas (sales, marketing, HR, IT, etc.), including financial due diligence.
  • Use due diligence to reveal unforeseen opportunities as well as important red flags
  • Understand how items uncovered during due diligence can affect deal structure and terms.
  • Utilize tools to organize due diligence findings

CPE Credit available.

Click to register: https://www3.gotomeeting.com/register/601246870