Due diligence: what are you looking for?

According to a substantial body of research, only about 30% of acquisitions achieve their investment objectives. While there are numerous reasons why this happens, much of the blame must fall back onto inadequate evaluation of the target firm and the investment justification. Basically, inadequate due diligence was undertaken.

The due diligence undertaken by the professional service providers is essential but somewhat conventional. They are going to examine the existing business to ensure the acquirer is fully informed of its operations, ownership, liabilities and obligations. These inspections are aimed at uncovering future risks, delays and costs inherent in the current business.

The potential buyer has the opportunity of factoring these findings into the price, revising their projected investment outcomes or walking away from the deal. This type of due diligence process is critical but only covers part of the evaluation.

The due diligence on the vendor operations can be utilised by any acquirer, but it is the combination of the vendor business and the acquired business which is critical to achieving investment objectives. Two other areas need to be carefully examined; change of ownership issues and post-acquisition operations.

Once the deal is done, most acquired companies go through a series of changes to put them into a state where they can be exploited by the buyer. This process often requires both intervention in the current operations as well as integration of all or parts of the vendor business with that of the acquirer. This period will often see internal systems change, jobs realigned, new management appointed, operations relocated and so on.

The due diligence task needs to review these intended changes and assess whether they can be undertaken within reasonable cost and time. Often such an examination will find that there are undue stresses, delays, disruptions and costs involved. What appeared to be an easy transition when negotiations commenced with the vendors can turn out to be an endless task undermining operations in both companies. Few integration processes go smoothly and many are abandoned.

Even if the business passes the test of inherent due diligence and transition, there still remains the question of how the investment objectives will be achieved. In developing the investment case, many assumptions will have been made about the state of the product/market situation and the operations of the combined entity. These assumptions need to be thoroughly examined to ensure they are realistic. Sales projections need to be validated, supply lines confirmed and costs verified.

Common problems which are often overlooked are the loss of key employees and the loss of customers. Acquirers need to anticipate problems which will occur during the change of ownership and after operations are settled in.

While many of these issues can be effectively managed, some early research into the marketplace and current employee expectations can show underlying problems which are not easily addressed. Sometimes when these are factored into the investment model, the acquisition fails to show it can achieve the desired result. In such situations, the acquirer is better off walking away from the deal.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.