Michael's M&A Playbook: 7 Tips for a Successful Due Diligence
Due diligence, in a sentence, is the process of collecting and analyzing information from the M&A target company. In a broader sense, the due diligence definition is any kind of research and analysis of a company for a business transaction. It is a crucial step in the mergers and acquisitions process map. There are many websites where you can download a due diligence checklist, but they are sometimes more textbook-based and theoretical. Here are some real-life examples from my M&A transactions that also show you links to the post-merger integration. Follow these tips to perform your next due diligence successfully. You can download a free due diligence budget template at the end of the article.
Mergers and Acquisitions Due Diligence Tips
Build a due diligence team with people from different functions - The main goal of a due diligence process is to understand the target company better and get more data on the financial performance. It includes the competitive situation, go-to-market strategy, operational processes and customer service, management of administrative processes, and financial statements. When you go through those topics, you immediately understand why the due diligence team needs to have a broad background and good business knowledge. Within a short time, you need to understand why the target has been successful, what doesn’t work currently, and where is an opportunity for improvements and synergies.
Combine internal teams with external experts - Certain elements in the due diligence are complex. Examples are the financial and tax due diligence, including a quality of earnings (QoE) report. The QoE report takes the reported financial statements and “normalizes” the numbers, i.e., it adjusts unusual topics and adds items that should be included (but are not there). I propose that you work with an external accounting firm for those due diligence items. When you have a target with R&D and product development, it may also be helpful to hire an external expert. I always found that combining internal teams and external experts results in a better analysis. Also, consider that the workload for people on the due diligence team is high, and adding external resources helps you to avoid overloading your employees.
Question everything in the reporting and planning assumptions - It may sound simple but don’t assume anything and question all information. An example from my M&A projects is that a target adjusted the lease payment in one of their locations because the parent company wanted to exclude a big portion of the rent from the operational performance. The reason was that a long-term lease had been signed even before the current owner bought the business. This adjustment was not mentioned in the due diligence material, and the long-term lease of the whole building came with the target. We found out late in the due diligence process, and it became a significant issue in the final negotiations. There are many other similar cases. Sometimes, you need to think more about what is not included in the numbers than what looks strange in the financial statements.
Develop a business case and value capture approach - Based on the information from the due diligence, work simultaneously on the business case. The different teams will help you with the input. For example, work with the marketing and sales due diligence team on future customer acquisition costs, necessary product development expenses, go-to-market marketing mix, and forecasted revenues. The technical due diligence team will help you with R&D estimates, and the operations due diligence group will develop forecasts for product delivery and customer service. The main question is how you add value to your company with this M&A transaction. This is the value capture question. How you answer it will determine whether you continue with the process or not. Remember, an M&A transaction is a stage-gate process where you have go/no-go decisions throughout the process at certain milestones. The business case and value capture analysis are examples of those gates.
Prepare an integration plan - You are still in the due diligence stage, but use that time to work on your integration plan. The IT due diligence stream will help you with the IT alignment assumptions, and the other due diligence teams will develop their approach. Ensure that the integration plan forecasts are correctly included in the business case and value capture analysis. Be specific, and don’t plan to solve all issues right at the beginning after the closing. It is crucial to create an approach based on priorities. The timing will also depend on the future management approach. For example, if you plan to manage the target separately for a certain time, a full IT integration can wait. The same question applies to other functions. Your assumptions about synergy capture, i.e., cost savings based on synergies, in the business case must reflect this accordingly.
Organize check-ins to exchange information between teams - The merger and acquisition due diligence can be complex because there are many different people and teams from inside and outside of the company. To ensure that everybody is up-to-date, organize weekly update calls where every due diligence team presents the main findings and issues in their workstream. This can become a daily call during critical times of the M&A transaction. Develop a simple template that every team follows for the check-ins. Invite the people who work on the business case and value capture analysis to those meetings. Also, include the team that works on the integration plan. In smaller companies, those are sometimes the same people, but in big companies, there are many teams in different time zones with different focus areas, and following a strict process and templates is crucial.
Work closely with the M&A project and negotiation leader - Usually, the M&A and negotiation project leader manages the whole M&A transaction but uses somebody else to organize the due diligence process. Depending on the company, this can be the head of M&A or the CFO. Whoever it is, ensure that you work closely with the M&A and negotiation leader. Keep regular check-ins and update the M&A project leader about the good and bad news.
Focus on a Data-Driven Value Capture
The most important element of the M&A due diligence phase is to develop a value capture approach that adds value to your company. After you finish the due diligence and have all reports, ask yourself whether there is a reasonable and achievable approach for the value capture. Do we add value with this M&A transaction or not? Ensure that the approach is data-driven and supported by business cases with different scenarios and risk adjustments. You still don’t have all of the information. Access to key people and data is still limited.
The tips above will help you to make the mergers and acquisition due diligence process successful. Feel free to contact me to discuss specific mergers and acquisitions examples.
Are you working on a due diligence budget and don’t know where to start? Click the button below to get a free Excel due diligence budget template. It’s a good starting point, and you can adjust it to your company and M&A project.
