What should you have in your M&A due diligence checklist?
It reaches a point in time when a company has met all business milestones, conquered local and international markets, and made huge profits.
The only idea you have then is to expand and tap into new markets. Two likely options you’ll need to consider are merging or acquiring other companies.
On the surface, mergers and acquisitions appear simple, but they are complex business transactions that require meticulous planning and execution to realize growth. According to a Harvard Business Review report, between 70% and 90% of mergers and acquisitions fail mostly because of inadequate due diligence.
These statistics might discourage you from proceeding with your plan.
But what if you knew what to consider to significantly increase the success rate of your planned M&A transaction?
Here is an M&A and Due Diligence checklist: the most important items to confirm before proceeding with a merger or acquisition.
1. Financials
A merger or an acquisition is done to improve businesses, especially in financial aspects. Hence, the first detail you should be concerned with is financials.
Seeking financial documents, even before the discussion begins, is a great way to start.
Browse the internet for news articles, and equity analyst reports. Interview experts, major customers, and competitors to get a good view of what its financials are like.
In negotiations, M&A and due diligence analysis of the company's financial statements go hand in hand.
Examine documents including income statements, balance sheets, and cash flow statements which enlighten you on the profitability and operation costs of the company.
Review both historical and predicted financials, as well as related financial metrics to see how the company has performed before, and how it is expected to perform in the future.
All these statements provide critical data that will help you make informed decisions.
You can identify areas that provide the best return on investment and ascertain whether you are okay utilizing the opportunities if the transaction goes through.
In addition, if there is inaccurate data notable through inconsistencies, you can avoid falling trap into a bad business transaction.
HP's acquisition of Autonomy resulted in a writedown of $8.8 billion, making it one of the biggest blunders of mergers history.
It turned out that HP did not conduct a comprehensive review of Autonomy’s financial data, which had grossly misrepresented and inflated numbers.
2. Intellectual Property
Following closely in your mergers and acquisition due diligence checklist is one of the most valuable assets the company can own.
Intellectual property (IP) is any nonphysical asset protected from unauthorized use by the law. This includes patents, copyrights, and trademarks, among others.
Data also falls under intellectual properties which makes Data Privacy a priority in your IP considerations.
Due diligence of IP helps determine whether there exists any transfer pricing and task risks associated with the intangible properties.
Here are some questions to ask yourself:
- Does the company have any domestic or foreign patents?
- Has it taken any measures to protect its intellectual property?
- Is the company intruding into any third party's intellectual property or vice versa?
Due to the complexities involved in this stage, consult an intellectual property attorney to review contracts and intellectual property inventories.
Upon establishing a company's intellectual property information, use both tax and accounting valuations to determine the value of the intellectual property.
Having intellectual property in your due diligence checklist for mergers and acquisitions protects both the company and you from unnecessary risks and prevents potential liabilities.
Paterson and Sheridan, an IP law firm, helped an international tech company lower the acquisition costs of an overseas entity by tens of millions of dollars through due diligence. The firm identified competitors' patents that affected the entity's main product and hence could negotiate the cost of acquisition.
3. Management
The structure and quality of the company management paint a picture of the operating model of a company which in turn gives you an idea of how management transition will be.
First, dive into the company's culture.
Since culture involves a myriad of business and personal aspects, you can expand your research with interviews, discussions, and online research on the company.
Almost 50% of mergers failures are a result of cultural differences and changing operating models according to a McKinsey survey. So you want to invest time and resources in these due diligence considerations for mergers and acquisitions.
Small changes, such as cafeteria options and expense policies can disorient employees, leading to poor business performance.
In anticipation of the resistance, you’re likely to receive, you ought to make a compelling case for change in your target company.
You can consult with an employment lawyer to review employee contracts, benefits, and policies, and use Content Intelligence Platform to analyze contracts and discover sensitive clauses that could potentially affect the transaction.
Without an extensive review of management issues, you can fall victim to the many unsuccessful mergers reported yearly.
One of the costliest acquisitions ever took place in 2004 when Time Warner acquired AOL. The acquisition resulted in a $99 billion loss, making it the biggest due diligence disaster ever at that time.
Guess the reason for the failure? Management issues.
4. Customers
With any mergers or acquisitions, you take over new customers.
Why not take time to understand the company's customer base before you consider any transaction.
Find out the characteristics of the largest concentration of its customers in the sales pipeline. This information will help you determine how challenging it will be to maintain the same customers, after acquisition.
A company having challenges with its customer base is likely to spill over the bad reputation to your business.
In addition, find out the seasonality of revenue, working capital requirements, distribution channels, and systems of the company.
Can it empower you to penetrate new markets and increase your market share?
Having customers in mind, in your M&A due diligence checklist: the most important items to confirm, forces you to seek information that gives you the confidence to expand.
Nevertheless, if you fail to conduct a comprehensive customer analysis of your target company, you have to face the challenges of meeting the needs of the unique customer base it comes with.
The merger between Nextel and sprint in 2005 was occasioned by devastated customer retention, as it lost 1.2 million prepaid customers, due to bad customer service.
Sprint had issues with customer service which affected Nextel reputation and resulted in a write-down of $29.7 billion
5. Competition
Lastly in your mergers and acquisitions due diligence checklist is finding the level of competition your target company has.
A merger or an acquisition is a means to an end. You have goals to expand and grow. That's why you've considered acquiring or merging.
Your target company's competitive environment is something you ought to be concerned about.
- What are its current and future competitors?
- Are there innovations that could make the company's current technology obsolete?
- Does the company's products or services have any advantages over its competitors?
Understanding the competitors’ strengths, market trends and the needs of the customers will show you where your target company is in the competitive landscape.
Using the five competitive models proposed by Michael E Porter, to evaluate competition can act as a strong foundation in your competitive analysis.
Failure to do competition analysis exposes you to risks of business failure due to tough competitors.
For instance, MySpace was acquired by News Corp in 2009 but later sold at a mere value of $35 million from $580 million due to tough competition from Facebook.
News Corp might have failed to conduct due diligence in competitive landscape analysis, and it did cost them dearly.
Conclusion
You obviously desire to reap major benefits from mergers and acquisitions. However, it is never a guarantee that all deals will be a success.
This M&A due diligence checklist: the most important items to confirm when negotiating a merger or an acquisition, gives you the confidence to proceed or withdraw depending on the business environment.
As a business owner, you should be vigilant about the possible pitfalls of joining hands with other companies.
While it offers an opportunity for growth, conflicts in operations, culture, and management, just to name a few, can result in irreconcilable differences that hamper the new conglomerate from moving forward.
