DD Guarantee: Due Diligence Is a Key Stage of Mergers and Acquisitions, and It's Especially Crucial to Get This Process Right When Economic Conditions Are Uncertain. Stewart Meek Explains How a Thorough Review, Incorporating a Well-Trained 'Virtual' Team Drawn from within the Purchasing Organisation, Can Be a Genuinely Value-Adding Activity. (Business Acquisitions)
Meek, Stewart, Financial Management (UK)
There is a school of thought that suggests the acquisition excesses of the internet boom years resulted from poor due diligence practice. But the reality is that the due diligence process starts only after the intention to purchase has been expressed--often with unbridled enthusiasm during the dotcom gold rush. If blame is to be attributed, it's possible that the findings of due diligence reviews were ignored and unwise deals were concluded regardless.
According to Denzil Rankine in Commercial Due Diligence (Pearson, 1999), the process simply "helps acquirers and investors to decide whether or not to commit their resources to a transaction". It has traditionally focused on financial and legal issues, but other important areas have emerged. The inclusion of commercial, HR and operations risks (and others, such as health and safety) means that fully comprehensive reviews are being conducted more often.
The acquirer wants to get into the detail as quickly as possible, while the vendor would rather wait until it receives an acceptable initial offer before letting anyone see its most confidential information. If there are several suitors, the vendor may prepare the due diligence material or commission a report to be used by all bidders, giving only those it has shortlisted unrestricted access. As a rule of thumb, broad screening should be conducted early on in the acquisition process and a more detailed analysis should occur during negotiations and the on-site review. Going into detail after the deal is completed is too late.
Figure 1, below, illustrates the four main stages of acquiring a private company, where normal principles of English law apply (rather than the purchase of a plc, which is subject to more complex rules). Stage 1 ensures that acquisition activity is in line with the strategic objectives of the organisation, and that it is a structured selection. The identification and selection of internal and external experts with well-defined roles "will greatly improve the chances of success and reduce the time and costs involved", according to the Company Acquisition Handbook (Tolley Publishing Company, 1996).
An initial offer may be unsolicited or a response to an invitation or auction. But, once the acquirer is in the game, stage 2 involves detailed work towards making a definitive offer. When the initial offer is deemed acceptable, the due diligence team springs into action and meets the vendor's management team. It's generally recognised that due diligence takes much longer in today's market conditions and the findings are purportedly used as bargaining chips in price negotiations.
Assuming that a negotiated settlement is reached, stage 3 focuses on deal structuring and the completion of documents. Planning for stage 4, integration, should then begin. The success of the transaction will depend on the ability of the acquirer to absorb the new business and deliver the benefits found in the planning and research phases. HR issues will be much to the fore, hence the heavy emphasis on communication at this stage.
Due diligence is an expensive activity, but the benefits can far outweigh the costs. Conducted properly, the picture of the target organisation, its business sector and its industry should become well understood by all of the key people in the acquiring company.
Scope is important: financial and legal due diligence are seen as the minimum reviews that should be completed, but three other key areas are commercial, management and operations. These are illustrated in figure 2, right, with the results from each fieldwork area feeding through to the review stage.
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The review seeks to corroborate the initial offer, which is likely to have been derived from internal desk research or documents supplied by the vendor, such as an information memorandum. Due diligence will try to identify deviations from the initial valuation, resolve risks identified by the research and uncover any new risks. …