Article
M&A success rates are improving, but about half of all large deals still fail to deliver the expected returns. The most effective deal makers use the due diligence process to spot potential land mines and uncover hidden value.
It may come as a surprise in an M&A landscape struggling to recover, but executives are getting better at deal making. What's behind the improvement? David Harding elucidates what the best due diligence practitioners do.
Executives have really improved their discipline at both ends of the deal value chain. They're getting much much better about staying close to their core and doing what is right. At the same time, they're actually getting much better at merger integration-all the activity that you have to do, whether it's a scale deal or a scope deal, to make the merger work.
If there's an issue at this stage of the game, it's in the middle of the value chain where you're looking at commercial due diligence and all the activities that lead you up to that critical decision: Do I close this deal or do I walk away?
The most successful acquirers in the world are actually the private equity companies when it comes to due diligence. And if you think about it, that is their fundamental difference. Most private equity deals are highly competitive-you might have 10 firms looking at it-and the company that can ask and answer the big questions and understand where the true value is going to be in the best position to succeed.
What the best diligence practitioners do is take all that information that is provided by the seller, provided by third parties and use that as the starting point. And then they go off and they test it. And they test it by talking to customers, by doing primary research, by talking to vendors to find out if the company is paying its bills on time. And in doing that, you can test the conventional wisdom. So, culturally, it goes beyond the audit function, it goes into an entirely new realm which is asking and answering the big questions.
In almost every deal there is a relatively short list of things that will ultimately drive the value in that deal. The value may come from hidden growth. And the questions that you want to ask about hidden growth-you go and you talk to the customers about whether or not there are additional products and services that you could potentially offer; new channels, new geographies. Maybe the deal thesis and the key value driver is around cost synergies. If that is the case then do we know where those synergies are going to come from? Do we actually think that we can realize them? And part of that may be going to talk to customers to see if the company is producing at a high level of customer service today, if they're paying their bills on time. Are they in a position to take the costs out of the business that we think they are?
Or perhaps this is more of a scope deal where they're getting into a new line of business that they haven't been into before. The number one rule of any scope deal is do nothing to destroy the value in the franchise that you've just overpaid to buy in the first place. And so the first question that you might ask is, can I keep the management team? Because if that management team just walks out the door then the value of my deal just walked out the door.
The number one trap is momentum to get the deal done. Because most of your advisors are going to have financial interest in seeing the deal through to completion, As you bring more people into the process, they're going to want to see this through to completion. And so the bias is, let's find a way to do this, no matter what we might find. It's hard to walk away from a deal.
One of the things that we always talk to our clients about is, early in the deal process, set a walk-away price. Set the conditions under which you're not going to do this deal. Write it down. Put it in your top drawer. Make sure that you always have the ability to walk away from a deal.
The reality is that the whole conception of deal-making is very glamorous. The execution of deal making is not so, it's down and dirty work in the trenches. And, as we think about diligence and the value that it provides; what it really is, is a margin of safety. Because, at the end of the day, there is nothing glamorous about stepping on a landmine.
First published in mayo 2010
