In QFinance, a very extensive on-line financial markets resource, I’ve written an article entitled ‘Due Diligence Requirements in Financial Transactions‘. Due diligence is a critical business intelligence process, and in our book on the use of business intelligence in doing M&A deals better (Intelligent M&A, Navigating the Mergers and Acquisitions Minefield), the chapter on due diligence is the longest. In it, I make the following arguments:
- There is an urgency for companies to conduct intensive due diligence in financial deals, both before announcement (when it should be easy to call off the deal) and after.
- Traditional due diligence merely verifies the history of the target and projects the future based on that history; correctly applied due diligence digs much deeper and provides insight into the future value of the target across a wide variety of factors.
- Although due diligence does enable prospective acquirers to find potential black holes, the aim of due diligence should be this and more, including looking for opportunities to realize future prospects for the enlarged corporation through leveraging of the acquiring and the acquired firms’ resources and capabilities, identification of synergistic benefits, and postmerger integration planning.
- Due diligence should start from the inception of a deal.
- Areas to probe include finance, management, employees, IT, legal, risk management systems, culture, innovation, and even ethics.
- Critical to the success of the due diligence process is the identification of the necessary information required, where it can best be sourced, and who is best qualified to review and interpret the data.
- Requesting too much information is just as dangerous as requesting too little. Having the wrong people looking at the data is also hazardous.
The whole due diligence can therefore be summarised with four ‘w’ questions: What? When and where? Who?
- What do you need to review? Be careful, as note above, of requesting too much as you may then only superfically review even the important things. Focus on the critical, the potential deal-breakers and the things you need to know to design the best post-merger integration (too often managers seek this information AFTER the deal, but by then it’s too late to design a proper post-deal integration strategy).
- When do you need the information and where do you find it? Much due diligence can be done even before a deal is announced … and even before you start discussions with the target. For example, you often don’t need to ask the target for their sales information: even if they are privately held and don’t disclose this information, you can get it from industry sources such as publications, government data bases, suppliers and customers. Management consultants can provide excellent market information. Thus think about whether you can get information from other sources early, as then you don’t waste time once the deal process has started in earnest (once you’ve contacted the target) on things that you could have found out from other sources. It also allows you to focus during the intense due diligence process on facts that are only available from the target itself: such as it’s strategic plans and key contracts (with managers, suppliers, clients, etc). Also, some information can safely be deferred until after the deal is done.
- Who reviews the due diligence information? This critical question is often mishandled because of the (often overemphasised) need for secrecy in the pre-deal announcement period. At that time in the deal process, the finance departments are often driving the deal on behalf of the CEO and Board. You then find accountants reviewing human resource due diligence (employment contracts, for example), IT systems and even looking at operational data. The experts in these area don’t yet know a deal is taking place, but they are best placed to review any due diligence. This continues after the deal is announced, when you’ll find those same accountants walking a shop floor or factory looking for problems. But one of your own plant managers is best placed to look at the target’s factory; your HR team knows best how an employment contract should be written and therefore whether there are problems with the contracts of target company staff. Expand the due diligence team to allow for this proper review by the proper people! And do not outsource the review of this critical process, as you will need the findings from the due diligence process for the entire period — often many years — of integration so you will want this information in-house.
Lastly, do not forget that even the target needs to do due diligence on the buyer: who would want to do a deal only to find out that the bidder could not complete the deal due to circumstances that could have been anticipated.