Proper investigation Featured

9:56am EDT October 28, 2005

Whether your company is considering a merger or an acquisition, the extent and focus of your due diligence can mean the difference between success and failure. Proper due diligence goes well beyond simply analyzing financial statements. It requires a full-scale investigation designed to uncover all the implications of a potential transaction.

Before your organization can evaluate whether an acquisition is worth its price tag, it must first identify not only what it is buying but also why, and define the strategic advantages it hopes to achieve.

Frequently, M&A transactions fall short of intended goals because disproportionate emphasis is placed on financial and legal matters, without considering the equally vital operations and integration issues. Developing a detailed execution strategy through adequate due diligence that properly addresses all aspects of the proposed merger is critical to ensuring the transaction’s success.

Operational due diligence assesses all aspects of the seller’s business — from customer relationships, employees and benefits to the facilities and equipment, technology and supply chain management — to determine the value or cost they bring to the acquiring organization.

Customer relationships, for example, may be the strategic motivation driving an acquisition. But it is a mistake to assume all customers can be bought. Without evaluating the factors driving customer loyalty and, accordingly, forecasting any projected customer attrition, there is a risk of developing inflated expectations with respect to customer retention.

Human resources issues can also curtail success. In any M&A transaction, there is a risk that your star performers may walk out the door if you do not keep them informed about their new roles. All of your employees will have questions and fears about the new organization and will need frequent communication throughout the process.

Clearly, leaving your organization vulnerable by divulging confidential intellectual capital or privileged trade secrets is not the intent. But the employees you wish to retain will need to be kept apprised of how the merger will affect their positions as well as any significant differences in their benefits package.

Physical assets should be inspected as well. Visit all of the seller’s facilities and inspect the condition of each, looking for equipment that may need to be repaired or replaced.

Also consider their locations compared to your markets and to your already established locations. Determine if you will need to close any of the facilities and if so, the cost ramifications, including severance pay for terminated employees, lease buyout costs or extensive environmental waste cleanup.

Technology is another area that can create significant post-transaction expense. If the two organizations lack compatible management information systems, you may have to manually convert the data from the second system, which can be a costly and time-consuming process. In addition, your organization will have to support two systems during this transition, resulting in lost time, money and momentum.

Be sure to scrutinize all third-party vendor contracts and suppliers carefully. The target company’s pricing agreements with its suppliers or minimum purchase requirements can affect the cost of your purchase.

You need to take into account whether the vendors will have the capacity to meet a significant increase in demand. Also consider whether you have the lead time required to switch vendors, if necessary.

The list of factors involved in evaluating a merger or acquisition is seemingly endless, but the importance of conducting comprehensive due diligence cannot be overstressed. The more you know about the target company, the more confident you can be that you made the right decision.

Darin Janecek can be reached at (630) 586-5307 or djanecek@crowechizek.com.