Article

Deal making: Using strategic due diligence to beat the odds

M&A success rates are improving, but about half of all large deals still fail to deliver the promised returns.

By David Harding and Hugh MacArthur

First published on Μαΐου 01, 2010
min read


It may come as a surprise in an M&A landscape struggling to recover, but executives are getting better at deal making. From 1995 to 1998, only one out of every four acquirers beat their peer index by more than 10 percentage points, according to Bain & Company research. From 2002 to 2005, the success rate had nearly doubled, to 45 percent or about one out of every two acquirers. What's behind the improvement? In our view, shaped by working on more than 1,800 M&A projects worldwide with corporate acquirers and more than 4,000 due diligence engagements for PE investors, the most salient factors are increased discipline at opposite ends of the deal value chain: Companies are completing deals with sounder strategic rationales, and they are executing more effectively on merger integration. Even with these improvements, however, about half of deals larger than $250 million fail to deliver the promised returns. The problem lies in the middle of the deal value chain: commercial due diligence. Only one in three business development executives we surveyed said they are satisfied with how their companies manage deal diligence. Too many executives treat diligence as an audit to confirm what they think they know, rather than a solution to the problem of "I don't know what I don't know." The focus on getting the deal done leads to reliance on conventional wisdom that flows from off-the-shelf information or standard industry research. In fact, diligence is a critical step to test and quantify what seems like a good idea. The key to effective diligence is recognizing that you are making an over/under bet versus the conventional wisdom. The most successful acquirers consistently uncover a deal's hidden upside, which allows them to bet the "over." But they are also careful to anticipate the downside fully, making sure potential risks are well understood. With that understanding, they can calculate when to bet the "under." The leading private equity firms are among the best practitioners of strategic diligence in the world. Their business models are built on identifying the hidden value in assets that are being thoroughly shopped. The top-tier firms know when to reach and outbid rivals and when to walk away. Corporate deal makers face a different set of diligence challenges. Most private equity transactions are set up as auctions, complete with data rooms and well-defined processes for selling the assets. Corporate deals are more often private, requiring the bidder to make educated guesses about the asset he or she is buying. Yet, while the deal processes are different, the diligence tools used by private equity firms are equally valuable in both settings. David Harding leads Bain & Company's Global Mergers & Acquisitions practice. Hugh MacArthur leads the firm's Global Private Equity practice.

It may come as a surprise in an M&A landscape struggling to recover, but executives are getting better at deal making. From 1995 to 1998, only one out of every four acquirers beat their peer index by more than 10 percentage points, according to Bain & Company research. From 2002 to 2005, the success rate had nearly doubled, to 45 percent or about one out of every two acquirers.

What's behind the improvement? In our view, shaped by working on more than 1,800 M&A projects worldwide with corporate acquirers and more than 4,000 due diligence engagements for PE investors, the most salient factors are increased discipline at opposite ends of the deal value chain: Companies are completing deals with sounder strategic rationales, and they are executing more effectively on merger integration.

Even with these improvements, however, about half of deals larger than $250 million fail to deliver the promised returns. The problem lies in the middle of the deal value chain: commercial due diligence. Only one in three business development executives we surveyed said they are satisfied with how their companies manage deal diligence. Too many executives treat diligence as an audit to confirm what they think they know, rather than a solution to the problem of "I don't know what I don't know." The focus on getting the deal done leads to reliance on conventional wisdom that flows from off-the-shelf information or standard industry research. In fact, diligence is a critical step to test and quantify what seems like a good idea.

The key to effective diligence is recognizing that you are making an over/under bet versus the conventional wisdom. The most successful acquirers consistently uncover a deal's hidden upside, which allows them to bet the "over." But they are also careful to anticipate the downside fully, making sure potential risks are well understood. With that understanding, they can calculate when to bet the "under."

The leading private equity firms are among the best practitioners of strategic diligence in the world. Their business models are built on identifying the hidden value in assets that are being thoroughly shopped. The top-tier firms know when to reach and outbid rivals and when to walk away.

Corporate deal makers face a different set of diligence challenges. Most private equity transactions are set up as auctions, complete with data rooms and well-defined processes for selling the assets. Corporate deals are more often private, requiring the bidder to make educated guesses about the asset he or she is buying. Yet, while the deal processes are different, the diligence tools used by private equity firms are equally valuable in both settings.

David Harding leads Bain & Company's Global Mergers & Acquisitions practice. Hugh MacArthur leads the firm's Global Private Equity practice.