Business purchasers historically have a poor track record of success in evaluating target companies.
According to mergerstat.com, there were 10,296 domestic mergers and acquisition in 2004, representing in excess of $820 billion in value. Academic studies predict an M&A failure rate of approximately 75 percent, which suggests that more than $600 billion invested will result in a significant loss.
Why does this happen? While mergers and acquisitions that proceed to close look good on paper, it appears that business purchasers often focus too narrowly on financial analysis to the exclusion of rigorous due diligence concerning cultural fit and human resource issues.
However, these issues are highly predictive of whether a transaction will succeed or fail.
When evaluating a target, the following cultural factors should be considered.
* Organizational philosophies. Determine whether similar business environments exist at both the buyer and the target. Are there similar decision-making processes, reporting structures, management responsibilities and autonomy levels, as well as similar employee incentive structure, motivation and drive?
* Strength of management team. Is the management team committed to the merger or acquisition? Without a true commitment or confidence in the transaction, it is likely that management will fail in navigating new territory and meeting new challenges.
* Location. Is the target located near an existing buyer location? Remote locations often present serious management obstacles.
* Employee morale. In a general sense, employees should be positive and inspired. Have the employees previously been through a merger or acquisition and been successfully assimilated?
Human resources issues
If the cultural fit of buyer and target appears to be good, a buyer needs to engage in a thorough HR analysis that consists of reviewing not only existing employee litigation and claims but also the target company’s employment practices and policies, with particular focus on equal employment opportunity, wage/hour, workers compensation and benefit issues.
Although actual charges of wrongdoing may not exist at the time of a transaction, a buyer that uncovers questionable employment practices is better able to assess future problems and more effectively evaluate the acquisition price of the target.
* Equal employment opportunity issues. Review the target’s affirmative action plans, audits, results, conciliation agreements, charges and proceedings. Insufficient or nonexistent documentation policies should raise a red flag.
* Wage/hour issues. Investigate compensation practices, a hot target for plaintiff class action lawyers. Improper classification of employees as “exempt” can cost millions of dollars depending on the pervasiveness and duration of the misclassification.
* Health and safety issues. What is the target’s record regarding accidents? Review OSHA claims and investigations and workers’ compensation history carefully. If the company is poor in this area, the potential exists for significant damage awards.
* Cost of existing benefits. Be certain to assess what it will cost to maintain the current work force.
In reviewing executive compensation packages, beware of golden parachute provisions, as well as options and extensions. Assess restrictive covenants to uncover costs that could be associated with competitive threats.
A focus on these types of people issues by a business buyer go a long way in uncovering potential problems in any acquisition. In the classic Stanley Kubrick cold war comedy, “Dr. Strangelove,” the president of the United States is unable to understand how a mentally unstable Air Force general could launch a nuclear attack on the Soviet Union despite the numerous technological and other safeguards that had been put in place to prevent such an attack.
By way of explanation, his military adviser, Gen. Buck Turgidson (played by George C. Scott), ultimately is forced to admit to the president that, “It appears the human element has failed us here.”
When conducting due diligence, business buyers would do well to remember Gen. Turgidson’s words and do all they can to assure that the human element will not fail them in an acquisition.
Robert E. Dewitt is a partner at Gambrell & Stolz LLP. His areas of practice are business, health care, mergers and acquisitions, and joint ventures/strategic alliances. Reach him at (404) 577-6000 or [email protected].