Warning: Deal killers ahead
Ill-conceived due diligence processes can lead to M&A disasters
- By John Allen
- Feb 02, 2010
The headlines these days are filled with merger and acquisition announcements. However, the headlines don’t tell you about the large number of transactions that never reach completion. Many transactions do not close because something goes wrong during due diligence. Although due diligence may not be exciting, it is critical to the success of merger and acquisition transactions.
Imagine this scenario: An entrepreneur invests more than a decade of blood, sweat, and tears building a successful government contracting business. The company is well positioned in all the right segments of the market and has a strong history of growth and profitability. The business owner is ready to retire and wants to sell the company. He accepts a $50 million cash offer from a well-capitalized buyer.
During an exhaustive due diligence process, the buyer discovers that the seller’s status as an S Corp. may be in jeopardy because the company inadvertently created a second class of stock when it established an equity incentive program for key executives. Sixty days after entering due diligence, the buyer withdraws its offer and $50 million vanishes before the seller’s eyes.
This easily avoidable situation happens too often. Few due diligence issues that might kill deals involve company positioning or strategy. Instead, the culprit is usually a nuts-and-bolts technicality. This includes unexciting things such as government contracting nuances, Service Contract Act compliance, inadequate export procedures, set-aside uncertainties, and improper employee classification. The list is virtually endless.
Sometimes one discovery isn’t to blame; a transaction can die a death by a thousand cuts. Many little concerns, each quite benign when taken individually, can create an adverse perception in the eyes of the buyer. Once this perception is created, it is virtually impossible to change.
Preparation is the key to avoiding due diligence catastrophe. Companies with a long-term eye toward a sale should consult with knowledgeable advisers to understand due diligence hot buttons and spot check their business to ensure they are on the right path. Businesses with a near term liquidity focus will be well served to hire highly experienced advisers that can provide the company with a thorough due diligence assessment before the first calls are ever made to buyers.
Not all advisers are created equal when it comes to managing due diligence considerations for sellers. Too many investment bankers believe that due diligence is a lawyer issue. The best sell side advisers know that managing due diligence is paramount to the success of a transaction. To that end, business owners should understand the due diligence philosophy of the advisers they select.
Virtually every conceivable issue that can arise during due diligence is solvable. Problems only arise when such issues are left to chance. A strategy aimed at leading buyers to potential trouble spots rather than allowing them to discover problems on their own typically creates a spirit of trust between the buyer and seller. With strong trust in place, buyers are more willing take an intellectual approach to solving due diligence challenges rather than an emotional one. Emotional responses are often the kiss of death for merger and acquisition transactions.
When it comes to due diligence, businessman and author Andrew Grove said it best: “Only the paranoid survive.”
John Allen is founder and CEO of Bluestone Capital Partners. He previously served as co-head of the defense and government services group at BB&T Capital Markets|Windsor Group.