News & Articles

Don’t skip your homework

Financial and legal aspects of an acquisition often get all the attention, letting operational due diligence fall by the wayside.  If performed properly, however, a thorough operations review can result in significant savings of time and money - preventing a bad acquisition and helping to facilitate post-merger integration.  Areas focus should include the target's management team, customers, vendors, inventory and processes and procedures

While the financial and legal aspects of an acquisition get the lion’s share of most buyers’ attention, operational due diligence can easily fall by the wayside. But that’s a mistake: Most acquisitions that fail do so as a result of operational issues following the merger.

The time and expense involved in performing operational due diligence may seem like a hindrance to sealing the deal. If performed properly, however, a thorough review can result in significant savings of time and money — preventing a bad acquisition and helping to facilitate post-merger integration.

Key areas of concern
The goal of due diligence is to identify potential problems before you make a bad acquisition or pay more than a company is worth. Generally, buyers review a seller’s financials and operations after they’ve signed a letter of intent (LOI), indicating a serious interest in buying the business and promising to keep information revealed during the due diligence period confidential. LOIs typically include clauses stipulating that you have the right to cancel the proposed deal if due diligence reveals negative qualities or if the company’s performance deteriorates before the purchase.

Operational due diligence encompasses a number of areas. Here are some you should focus on when performing your review:

Management team. Your acquisition target’s management team and other key employees are critical to the success of the business. During due diligence, look into these leaders’ backgrounds and review their skills, effectiveness and motivations — including their willingness to support a new owner and new goals.

Executive compensation is another important issue to consider. If your company offers significantly different compensation, this is likely to cause conflicts between you and the acquired company’s management.

Customers. Customer due diligence can be tricky because most sellers don’t allow contact with customers until the deal is either in the final stages or completed. To circumvent this obstacle, propose distributing a satisfaction survey to the seller’s customer base. The survey might ask customers to rank the company on product or service quality, price competitiveness, customer service and their overall satisfaction. You might also ask what factors enter into their purchasing decisions.

The customers’ overall satisfaction and loyalty can help support — or possibly refute — financial projections that are being relied on to set the business’s purchase price. If your customer survey identifies potential concerns, you may want to revise your offer price or even terminate the transaction.

Vendors. Audit vendors to ensure they provide quality supplies in a timely manner and at a competitive price and are flexible about lead times and payment terms. Also ensure the selling company doesn’t rely too heavily on any one supply source.

Reviewing vendors and their relationship to the selling company can provide many valuable insights into the internal workings of the business. For example, you can glean information about the company’s reputation based on its delivery on financial commitments.

Inventory. Inventory turns are likely to be computed as part of the financial due diligence process. But it’s also important to look at turns by major products and product lines and test the actual condition of inventory on hand. Pay particular attention to excess and obsolete inventory items.

Processes and procedures. Reviewing a business’s processes and procedures allows you to assess their current effectiveness and identify future integration challenges. Review everything from customer sales returns and allowances to customer credit procedures and collection policies to employee benefit programs. A formal review of existing information technology (IT) systems and a compatibility assessment with your company’s systems are also recommended.

Avoid surprises later
Performed properly, organizational due diligence can be an effective form of acquisition risk management. Too many companies give this part of the M&A process short shrift. Don’t let your company make that mistake and learn the hard way that the business you’ve bought is very different from the business you thought you were buying. •