The Idea in Brief

Is your company prone to "deal fever"-getting so excited while pursuing acquisitions that it skimps on due diligence? Caught up in the thrill of the chase, many firms use due diligence to justify the deal rather than to uncover potentially serious problems.

To introduce discipline into your due diligence, Cullinan, Le Roux, and Weddigen recommend putting potential acquisitions' strategic rationale under the microscope: Probe for targets' strengths and weaknesses, and dig for unreliable assumptions. Be prepared to walk away.

Asking four questions can protect your company from ending up with a bad bargain:

• What are we really buying? (What would the acquisition bring, in terms of customers, competitors, costs, and capabilities?)
•  What's the target's stand-alone value? (Your purchase price should reflect the target as it is, not as it might be once acquired.)
•  Where are the synergies?
•  What's the most we're willing to pay?

Cullinan, Le Roux, and Weddigen offer these guidelines for evaluating a potential acquisition:

WHAT ARE WE REALLY BUYING?

Instead of relying on information provided by the target company, build your own view of the target by gathering information on its:

• Customers: Who are the target's most profitable customers, and how well is it managing them? For example, how do its customers' profitability or vulnerability compare with those of the target's competitors?
• Competition: How does the target compare to rivals in terms of market share, revenues, and profits-by geography, product, and segment? How might its competitors react to the acquisition?
• Costs: Is the target performing above or below cost expectations given its relative market position? Why? What's the best cost position you could reasonably achieve by acquiring the target?
• Capabilities: What capabilities-management expertise, technologies, organizational structures-does the target have that create definable customer value?

WHAT'S THE TARGET'S STAND-ALONE VALUE?
The vast majority of the price you pay for an acquisition should reflect the business as it is, not as it might be once you've won it. To determine stand-alone value, strip away tricks used by targets, such as stuffing distribution channels to inflate sales projections. Send a team into the field to see what's really happening with the target's costs and sales. If the target's hesitant or hostile about your investigation, steer clear.

WHERE ARE THE SYNERGIES-AND DANGERS?

Assess the value of the acquisition's potential cost and revenue synergies by:

• Estimating how long they'll take to achieve. You can gain some synergies (such as eliminating duplicate functions) quickly. Others (such as selling new products through new channels) take much longer.
• Assessing the probability of success. Some synergies (such as combining facilities) have lower success rates because they involve complex personnel and regulatory issues.
• Considering integration costs. Anticipate post-acquisition events that can sap revenues or increase costs, such as defections of talented employees.

WHAT'S OUR WALK-AWAY PRICE?
Your walk-away price is the top price you're willing to pay when the final negotiation is conducted. When establishing your walk-away price, give most weight to the current worth of the target company, and don't overestimate synergies' potential value-which may not materialize. Assemble a team of trusted individuals, less attached to the deal than senior management, who can provide an unbiased examination of the target and hold everyone to the walk-away criteria.