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Understanding the M&A lifecycle
Signing the deal to buy or sell a company is often the most memorable moment for those involved in an M&A transaction. However, it is only one of the stages within the M&A lifecycle, in which each step impacts the other ones. In this article we will take a closer look at the third step: due diligence.
More than skeletons in the closet
The indicative offer has been made, the Letter of Intent (LoI) has been signed, and so we have reached the next step of the M&A cycle: performing due diligence – often described as ‘finding the skeletons in the closet’, or more generally, matters that impact price/valuation or contract terms. And indeed, you might find some scary stuff. For instance, it turns out that the largest client of your M&A target (30% of total sales) has just terminated their contract. Or maybe you will find that there are certain tax positions that will impact valuation. Or that some creditors are being stretched, due to liquidity constraints. Scary – and useful, if you don’t want to pay too much and if you aspire to move smoothly through the next stages of the M&A cycle. Yet, however relevant these ‘skeletons’ are, due diligence can mean so much more.
Commercial due diligence
For instance, there’s commercial diligence. You may want to acquire a start-up or a scale-up. Many of those have only been investing until recently and have only just started to make money. If you want to predict their future sales and market development (which is often quite challenging in TMT, as products are often developed when there is no market demand yet), you could opt for a commercial diligence. This requires deep market expertise as well as a network of (potential) clients who will honestly share their opinions on e.g. new technologies and their willingness to start using them.
IT, technical, and operational diligence
Another type of diligence that is on the rise, is in-depth IT platform diligence. Is the platform that is being used, sufficiently – and easily – scalable, or will you run into certain limitations in the short term? How digitally secure is the target, is penetration testing required? Or technical diligence: are the machines that are being used by the acquired company (which are sometimes acquired second-hand to limit initial cash-outs) fit to support future growth? Finally, operational due diligence. Even if buyer and seller work in the same industry, there might be crucial differences. One company may be more advanced in automation, and have a state-of-the-art production facility, while the other one might focus on product development, a lean-and-mean back-office and transformation from brick-and-mortar stores to online business. An operational due diligence can offer insight into the assets you are acquiring and how this fits into your own organisation.
Preparing for the integration
Hopefully you don’t find any skeletons at all during the due diligence stage and preferably the assumptions you have made earlier on in the M&A cycle are confirmed by the due diligence. But even if some of the findings will impact the price, you need to focus on a wide array of matters. For instance, the due diligence stage should also be used to check the quality standards of the acquired company and its people, and identify factors that will help your organisation in the next stages of the M&A cycle. And there are factors such as synergies and dyssynergies as well – what are the quick wins, how will you create and maintain synergies in the short term, and how can you prevent the detrimental impact of any dyssynergies? Due diligence can also help you identify risks and opportunities, including unforeseen capabilities – people with skills and capabilities that could be of more value in another part of your company.
Performing due diligence is also the stage in which you should find out everything you need to know to execute the deal. Which competition authorities must approve the acquisition? What compliance risks are involved – especially in countries far outside the EU? How to deal with management fraud? So this phase could require all kinds of forensic work. And don’t forget another major question: what will happen to the governance structure of the M&A target? Will the current management remain in place or do you think another form of governance should be established?
The cultural fit
And there’s the ‘cultural fit’. How are the teams of both companies (buyer and seller) going to work together? Do they share values and goals? What makes these people ‘tick’ and which employees create a positive mindset within their department? For instance, a corporate may decide to acquire a company to improve and extend the corporate’s cyber security team. On the surface, this is an interesting proposition, offering all kinds of synergies. But what if the acquisition – and its management – doesn’t get along with your management, simply because they have always been in each other’s way? Merging these companies might be too big a challenge for the both of them. So it’s pivotal to have as much insight into the organisation and its people as possible, from an alignment of benefit packages and wider HR diligence to – in some cases – an assessment of its management.
Coordination and streamlining
Doing too many types of diligence can make coordination of all the work streams quite challenging. You will need strong project management that brings together the key findings of all subject areas. Also, a lot depends on the process management skills of the seller and their advisor(s). Have they sufficiently prepared the process, e.g. with specialists who have prepared sell-side documentation (VDD or IM)? There is a big difference between doing diligence at a company with experienced and well-prepared sellers, and first-time sellers.
Moving on to the next stage: the execution
Then, finally, you will come to an overall conclusion: are you still interested in buying the company? Sometimes, the conclusion will be that the M&A process should stop here and now. But if not, you can use the results of the due diligence to improve and speed up towards the completion of the transaction. What method are you going to use to conclude on the final purchase price – completion accounts or locked box ? We will dive into this question – and a few more - in the next step of the M&A cycle: the execution.
The M&A cycle in a nutshell
Below we have embedded a picture of the M&A lifecycle and a short description of each phase. In the coming months we will publish a series of articles on each step of the M&A lifecycle, sharing stories and thoughts about each of these phases of the M&A lifecycle to offer you insight in the entire process and help you benefit from the promised returns of a deal. In the lifecycle we will emphasise the integration of your steps and actions, and what might happen if you deal with every step in isolation.
Identify the Right Deal. Either through active selection of companies or business units, or by reacting to offers in the market (one-on-one or by auction). This phase involves setting corporate strategy, identifying growth areas or selling non-core activities.
Pricing and offer. Initial pricing of a company and assessing how easy or difficult integration or separation is going to be, as well as which legal and tax structure will be most suitable (and its impact on pricing).
Perform due diligence. What do we buy? It is crucial to assess the real value of the company, the presence of ‘skeletons in the closet’, financial aspects such as balance and cash flow as well as non-financial analyses (e.g. company culture, integrity, operational synergy benefits, and operational analysis of real estate).
Execution. After the due diligence phase, a Sales and Purchase Agreement is drafted, the relevant authorities are informed and consulted, and the ‘closing’ procedures are executed.
Deliver the Promised Returns. After the transaction has been completed, the expected results must be achieved – how to realise synergies and to prevent that in a future strategic re-assessment the new business will be considered as a non-core activity and be resold (without any added value). And the final step: Post-Merger Integration.
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