DOES PRE-ACQUISITION DUE DILIGENCE APPROACH NEED TO BE REFRESHED, CHANGED OR SIGNIFICANTLY MORE COMPREHENSIVE ?

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Balancing Legal, Financial and TRUE DILIGENCE

 

What Accountants and MBA qualified Corporate Finance specialists do

 

With traditional pre acquisition due diligence and pre- merger selection, the work is left to armies of accountants and Corporate Finance specialists with MBA’s and glowing laptop computers who expertly review figures, model ratios, devise “what if” scenarios, undertake NPV calculations, model alternative financial futures using Monte Carlo simulation and devise future financial strategies based upon what they can discern from the public records of  actual and potential competitors.

The results are very impressive sets of figures, automated spreadsheets, profitability analyses, balanced scorecards, bar charts and expertly modelled scenarios by division, by product group and by  sub product and by channel.

 

Legal Firms

 

The second wave of traditional due diligence is conducted by lawyers.

They spend hours of billable time examining contracts on buildings, IT systems, contractual arrangements with suppliers, potential suppliers about to be used, personnel contracts, directors service agreements, secrecy agreements, NDA’s, Non- Competition Agreements, current impacts of past and ongoing litigation and the “Holy Grail” of where does the IP lies and what the acquiring company needs to do to safeguard it’s position.

This is not all that they do of course but even these items plus the work of the accountants ought to make the business case for acquisition or merger, assuming goodwill on all sides, pretty compelling?

The answer in most countries is yes which is why so many acquisitions and potential mergers end up in tears.

 

Why does this happen?

 

The Whole Story

 

Accountancy and lawyer driven pre-acquisition due diligence is very necessary but it does not tell the whole story.

It does not look for example at people who after all represent on average 67% of the costs of an enterprise and who are divided into top performers, usually 10% of a workforce, average performers (usually 80% of people in a given workforce irrespective of sector) and underperformers (usually the remaining 10% of a given workforce).

All it will tell you is that you have 25% or 45% or some other figure, too many staff , you will not necessarily know who to keep, who to train, who to let go and who to outplace because you will have to discover that AFTER you have spent your money by which time the unpalatable truth will emerge courtesy of your HR department assuming they are up to the job.

Upon making the acquisition, you will have met the board and senior management but how much do you really know about them?

Accountancy and lawyer led due diligence will not tell you very much and all you will have to go on is your own personal judgement.

Your judgement and that of your fellow directors will have to be spot on and it can only be that way if you have all the facts (soft and hard) at your disposal.

If the directors of the target company are people in your image and with similar backgrounds and viewpoints and you are relying on accountancy led and lawyer led due diligence to fill in the gaps in your knowledge, you are ,based on the record of failed acquisitions and mergers in most countries, odds on to fail.

Reverse engineering the CVs of directors and senior management will reveal all sorts of gremlins and unwelcome facts as we saw with the US MD of Apple who was forced to resign when anomalies between his background and the facts emerged.

You might wonder at the ROI from this work but a good director or employee will outperform his/her more pedestrian counterpart by an average of 3.2 to 1.

Traditional due diligence does not look at cultural fit, the compatibility of your board with that of the target company, the match between your pay scales and theirs, recruitment methods, competitiveness in the marketplace, risk optimisation, negative trends on social media which could cause the share price of a target company to implode even as all today’s indicators show the trends for share price values to be on a steep and upward curve.

IT and software accounts for about 20% to 25% of total business costs yet under traditional due diligence this too is frequently ignored until the 11th hour or not considered at all.

If you are a Director of a Chinese company engaged in “Swarming Out” or you are from another South East Asian country, your requirements can be translated into a better fit with an appropriate acquisition within a Western country.

It is a good idea to use specialist tailor made consultants (from IT, brand management, Social Media, Export ) with international backgrounds encompassing not just UK, US and European business but long periods spent in the Middle East, Africa, Latin America, China, Vietnam Japan, South Korea, Malaysia and Singapore or Eastern Europe. Well travelled , multi-lingual analysts often think deeper and further.

We know from McKinsey’s that 50% of competitors to any given company did not exist before 2 years ago so our pre acquisition due diligence (or True Diligence), looks at agility, adaptability, expandability, speed of decision making (yours versus the target),resilience and robustness.

This along with risk optimisation and future proofing techniques adapted from Pentagon war gaming techniques and adaptive analytical frameworks applicable to your situation allow additional determinants of value to be unearthed, so that you do not overpay and it also allows you to walk away from deals which, whilst appearing attractive are, in business terms, traps for the unwary.

 

Marketing/Capability for Expansion and Exporting

 

It is wise not to just look at the potential acquisition in terms of what it has done historically or what it is doing now, because that limits the scope of our investigation to a point where you will know little more than you do now or would have known with traditional accountancy and lawyer led pre-acquisition due diligence.

We will look at the” headroom” in terms of capability and capacity improvement of the workforce, the ability of the incumbent board (the one you will be buying),to change and adapt themselves to the cultural differences that operating overseas is going to bring. This eliminates the problem of insular directors who think of “abroad” as somewhere where they go on holiday and of anyone outside their alumnis as “not one of us”.

It also helps to shape the boundaries of export led activities by channel so that the right mix is determined from Day 1 along with relevant language capabilities.

Appointing commissioned agents might seem superficially attractive but do they have divided loyalties and will they represent you as well as one of your own employees or a dedicated “white labelled” sales/call centre operation as a supplement to websites and social media activity. In some countries, agents own the client relationship under law.

 

Branding

 

Each marketplace has its own cultural norms so a UK brand may mean one thing in that country, something else in France, something different in Germany and nothing at all in China.

The same can apply in reverse and in other contexts.

Each case is different and each brand will have its own strengths and weaknesses and its own ability to” translate” into another culture or market before additional work is done to effect optimisation to the required level.

Understanding these differences as part of the Non-Financial Due Diligence or True Diligence process makes importantly allows you to better determine value before you have spent any money on an acquisition or merger you should not have embarked upon or rejected one which others have completely overlooked.

Written by John.A.Gelmini, Associate Director of Transaction Focus Balancing Legal, Financial and TRUE DILIGENCE

 

What Accountants and MBA qualified Corporate Finance specialists do

 

With traditional pre acquisition due diligence and pre- merger selection, the work is left to armies of accountants and Corporate Finance specialists with MBA’s and glowing laptop computers who expertly review figures, model ratios, devise “what if” scenarios, undertake NPV calculations, model alternative financial futures using Monte Carlo simulation and devise future financial strategies based upon what they can discern from the public records of  actual and potential competitors.

The results are very impressive sets of figures, automated spreadsheets, profitability analyses, balanced scorecards, bar charts and expertly modelled scenarios by division, by product group and by  sub product and by channel.

 

Legal Firms

 

The second wave of traditional due diligence is conducted by lawyers.

They spend hours of billable time examining contracts on buildings, IT systems, contractual arrangements with suppliers, potential suppliers about to be used, personnel contracts, directors service agreements, secrecy agreements, NDA’s, Non- Competition Agreements, current impacts of past and ongoing litigation and the “Holy Grail” of where does the IP lies and what the acquiring company needs to do to safeguard it’s position.

This is not all that they do of course but even these items plus the work of the accountants ought to make the business case for acquisition or merger, assuming goodwill on all sides, pretty compelling?

The answer in most countries is yes which is why so many acquisitions and potential mergers end up in tears.

 

Why does this happen?

 

The Whole Story

 

Accountancy and lawyer driven pre-acquisition due diligence is very necessary but it does not tell the whole story.

It does not look for example at people who after all represent on average 67% of the costs of an enterprise and who are divided into top performers, usually 10% of a workforce, average performers (usually 80% of people in a given workforce irrespective of sector) and underperformers (usually the remaining 10% of a given workforce).

All it will tell you is that you have 25% or 45% or some other figure, too many staff , you will not necessarily know who to keep, who to train, who to let go and who to outplace because you will have to discover that AFTER you have spent your money by which time the unpalatable truth will emerge courtesy of your HR department assuming they are up to the job.

Upon making the acquisition, you will have met the board and senior management but how much do you really know about them?

Accountancy and lawyer led due diligence will not tell you very much and all you will have to go on is your own personal judgement.

Your judgement and that of your fellow directors will have to be spot on and it can only be that way if you have all the facts (soft and hard) at your disposal.

If the directors of the target company are people in your image and with similar backgrounds and viewpoints and you are relying on accountancy led and lawyer led due diligence to fill in the gaps in your knowledge, you are ,based on the record of failed acquisitions and mergers in most countries, odds on to fail.

Reverse engineering the CVs of directors and senior management will reveal all sorts of gremlins and unwelcome facts as we saw with the US MD of Apple who was forced to resign when anomalies between his background and the facts emerged.

You might wonder at the ROI from this work but a good director or employee will outperform his/her more pedestrian counterpart by an average of 3.2 to 1.

Traditional due diligence does not look at cultural fit, the compatibility of your board with that of the target company, the match between your pay scales and theirs, recruitment methods, competitiveness in the marketplace, risk optimisation, negative trends on social media which could cause the share price of a target company to implode even as all today’s indicators show the trends for share price values to be on a steep and upward curve.

IT and software accounts for about 20% to 25% of total business costs yet under traditional due diligence this too is frequently ignored until the 11th hour or not considered at all.

If you are a Director of a Chinese company engaged in “Swarming Out” or you are from another South East Asian country, your requirements can be translated into a better fit with an appropriate acquisition within a Western country.

It is a good idea to use specialist tailor made consultants (from IT, brand management, Social Media, Export ) with international backgrounds encompassing not just UK, US and European business but long periods spent in the Middle East, Africa, Latin America, China, Vietnam Japan, South Korea, Malaysia and Singapore or Eastern Europe. Well travelled , multi-lingual analysts often think deeper and further.

We know from McKinsey’s that 50% of competitors to any given company did not exist before 2 years ago so our pre acquisition due diligence (or True Diligence), looks at agility, adaptability, expandability, speed of decision making (yours versus the target),resilience and robustness.

This along with risk optimisation and future proofing techniques adapted from Pentagon war gaming techniques and adaptive analytical frameworks applicable to your situation allow additional determinants of value to be unearthed, so that you do not overpay and it also allows you to walk away from deals which, whilst appearing attractive are, in business terms, traps for the unwary.

 

Marketing/Capability for Expansion and Exporting

 

It is wise not to just look at the potential acquisition in terms of what it has done historically or what it is doing now, because that limits the scope of our investigation to a point where you will know little more than you do now or would have known with traditional accountancy and lawyer led pre-acquisition due diligence.

We will look at the” headroom” in terms of capability and capacity improvement of the workforce, the ability of the incumbent board (the one you will be buying),to change and adapt themselves to the cultural differences that operating overseas is going to bring. This eliminates the problem of insular directors who think of “abroad” as somewhere where they go on holiday and of anyone outside their alumnis as “not one of us”.

It also helps to shape the boundaries of export led activities by channel so that the right mix is determined from Day 1 along with relevant language capabilities.

Appointing commissioned agents might seem superficially attractive but do they have divided loyalties and will they represent you as well as one of your own employees or a dedicated “white labelled” sales/call centre operation as a supplement to websites and social media activity. In some countries, agents own the client relationship under law.

 

Branding

 

Each marketplace has its own cultural norms so a UK brand may mean one thing in that country, something else in France, something different in Germany and nothing at all in China.

The same can apply in reverse and in other contexts.

Each case is different and each brand will have its own strengths and weaknesses and its own ability to” translate” into another culture or market before additional work is done to effect optimisation to the required level.

Understanding these differences as part of the Non-Financial Due Diligence or True Diligence process makes importantly allows you to better determine value before you have spent any money on an acquisition or merger you should not have embarked upon or rejected one which others have completely overlooked.

Written by John.A.Gelmini, Associate Director of Transaction Focus