Let’s start with an overview of your approach to due diligence.
Having a dual legal business background has given me an interesting perspective. The way I started thinking about diligence revolves around how do you coach your diligence team beyond just the legal side to prioritize and identify quickly material items that could impact the investment thesis.
How do you do that while at the same time following up on all the legal risk-oriented issues that you need to find, that may be a red flag to even move forward with the transaction?
How do you do that while starting to layer in the integration planning into due diligence, so that diligence becomes not just risk finding, but also includes planning and gathering information that can be used to finally develop the integration plan and execute it post-closing?
You try to avoid leaving as many hidden issues as possible and not kick the can to post-closing.
So you’re looking for those surprises ahead of time for the integration team?
Absolutely. And you also try not to make mountains out of a molehill. If you’re on the outside, you have to understand your client well and on the inside, you try not to let issues get raised that are maybe easy to address.
Even though an issue is one that needs to be addressed and put into a mitigation plan, it does not negate the value of the acquisition, so that the team’s effort should be spent on mitigating it, so that it doesn’t distract senior leadership away from the issue.
How would you go about prioritizing those risks and legal issues that come up?
Essentially, you are focusing on 20 percent of the issues that are specific to the deal and 80 percent of activities that are kind of standard for most acquisitions. Then, you give the team the investment thesis highlighting where you think the value is.
At this point, you can’t do due diligence because you still have limited information that’s either under NDA or publicly available.
These are the hypotheses that need to be tested as quickly as possible because if the key value drivers for the acquisition don’t get substantially invalidated, you can end up with a notion that finding those 20 percent legal issues or finding a major potential cost is irrelevant and you are not doing what you need to do, which is focusing on those key value drivers.
Once those get checked, you start going down to the next level and understanding whether there is some hidden cost or whether there are major legal issues that may or may not be able to be addressed post-closing or in the purchase agreement.
So, when you look at the top few things you look for during diligence, are there standard things that you would look for in every deal, or are they primarily driven on the identified key value drivers for doing teh transaction?
I think it’s a hybrid. You definitely have to prioritize key value drivers, which are the four to five key items that you identified. The next tier down is more industry-specific.
For example, if you are on the sales side of things, you know the temperament of that field, you have to prioritize the issues that your acquisition could do to impact the sales force, and whether the sales force that you are acquiring is the kind of team that can be successful in your environment. That’s a cultural thing.
For manufacturing deals, for instance, environmental issues will be something that needs to be addressed. Every company has different hot button issues, a lot of them coming from previous bad experiences on acquisitions.
Your team needs to be aware of those issues and they need to successfully spot those hot buttons early in order to calm those potential fears early, so they don’t rise up later and disrupt the process internally, which always sends a bad message to the sell-side.
How do you present your risk? When you are going through the diligence process and you come across something significant, how would you take that back to the seller?
There is no one size fits all answer. The initial thing is an internal review where we identify the M&A risks and identify whether there is additional information and try to figure out how to obtain that information to try to quantify and validate that risk.
Once you have those potential solutions set in order that gives you the right conversation with the right potential. A lot of the time, the issue lies in the information gap, in cases where, for instance, it didn’t come as early as it should have in the data room or due diligence request list.
If that happens, the next thing you want to do is try to find a solution to fix it as quickly as possible. Not being able to offer a solution or an explanation, if you are the seller, really makes you a less attractive bidder.
Have you ever find your self at a war with another legal team?
In my experience, lawyers fall into two camps. One is the group with a more business orientated mindset, and they are trying to get two parties together, address the issues so that everyone is happy and the transaction can go forward.
The other group is the one that treats everything more like litigation and thinks that everything is a zero-sum game and winning points, which is very frustrating and to me, speaks about inefficiency. A good counsel keeps things in perspective. They don’t take a legal risk and make it the linchpin to the success of the transaction.
This definitely ties back to that alignment of goals and objectives.
Yes, and even though there are definitely people on the transaction that only come around at certain points in the deal, instead of treating these things as siloed activities to accomplish acquisitions, it is important to look at it holistically and say all these things tie together.
Now, you mention that you guys plan integration early. How do you take that into consideration when analyzing your target? How much is it going to cost and what’s going to go into it to integrate the company?
Looking at integration complexity at the time of target identification is something that’s overlooked and one of the easiest ways to enhance your probability of being successful with what you are trying to achieve.
Thinking about integration is one of those elements that help you clarify the ultimate goals. Do we want to go through this process? Does what we need to achieve require us to acquire and integrate?
What are some of the hardest things you’ve had to face during international transactions?
There’s enough cultural diversity in the United States alone to create challenges from an integration standpoint and post-closing an acquisition. I have seen people make wrong assumptions that because targets are located in the UK things will be easier because you share the common language.
But, the fact is, as an example, you might have more line culturally from the way your business runs with the German company. If you get scared to go after the opportunities in regions where it looks very different than you are used to because of the cultural differences.
Even though I have years of negotiating experience, a strong corp dev team, and investment bankers, I still like having a local buy-side adviser to make sure I don’t mistakenly step on landmines culturally. Some countries are more of a challenge than others.
What was the hardest country you had to work with?
One of the most challenging is doing transactions with companies that are based in Central Asia, where transactions may take longer than we are used to here in the US, due to family legacy issues and similar matters.
How do you validate for cultural fit?
If affordable, I believe it’s very useful to an outside adviser who specializes in this to help you quantify the target’s culture.
- How do you deal with conflict in your environment?
- How about customer or supplier complaints?
- How do you ask for a vacation?
These are the little things that, if you try to change them post-closing, can have more material impact than you’d like.
You also need to think about what’s your true culture.
- What are the elements of your culture, such as the reality of day to day that you need to be aware of and quantify?
When you have an acquisition scenario and you are acquiring a target manufacturing operation if you put that same leader, who may be wildly successful in your organization, into the target and expect them to alarm you quickly when issues are going to arise so that you can address them, you may create a problem.
What if that person never acquired a company before?
In reality, you are creating a scenario where they’re not likely to be successful and you are increasing the probability that issues get hidden until they become material problems, which means sometimes it’s too late to address them or the financial impact is much more difficult to mitigate.
How would you look at some of those underlying details to figure out the culture?
One way to do it, that’s more neutral, is by using the sources such as reaching out to firms that can connect you with those that are consulting to give advice, to potentially find a former employee who is willing to participate on the call where you have them asking questions about the culture.
Of course, they have their personal, subjective view, which needs to be taken into a count when conversing.
The other thing is, you have your front team, the people who are key to diligence, integration, and planning, and you can have them go on-site and meet some of their counterparts. They have a biased view of the acquirer’s culture already and they should focus on listening and gathering information.
A strong corporate development team that has an understanding of how to filter their own internal team, take what they saw on-site, and combine those two, can provide a much better overall picture of the culture or at least where the potential hotspots or opportunities for improvement are.
How do you measure success on these deals?
I see it in layers. Success is proving that value drivers exist and that they execute on post-closing, it is seeing that in the first six months to a year things are moving along as you planned, that the value capture is happening and the synergies are appropriate to a deal or above the initial hypothesis and that you are able to achieve revenue synergies.
Do you keep a specific scorecard around synergies that were planned and obtained?
I think that’s the best practice. How complicated that scorecard is depends on the company, the internal metrics, reporting, and deal specifics. In general, if something is off in the first six months, it has less than 10 percent probability of being on a plan in five years.
In other words, if something is off, that needs to be addressed as quickly as possible because that’s the only probability of getting where you need to.
Scorecarding is one way to quickly assimilate information, raise issues, and get the team to solve them or allocate resources, time, and money to that problem to get it solved quickly, so it’s less of an interruption.
There will always be some issues, so if you have not planned well and if you are not keeping a scorecard, dealing with those can be a problem going forward.
You are very people-focused versus financially focused in scoring transactions.
You get your top line, the bottom line, your margins, and your tracking - those are easy things to report on based on the numbers you see. M&A is a very complex process and the integration, the most important part of M&A is very challenging and you need all hands on deck, and you everybody inside your organization helping to solve the inevitable things that pop up.
Looking back at your experience on transactions, what would you say are the biggest lessons you’ve learned?
Patience. Patience on deals and patience in planing to understand other cultures. It’s important to be empathetic and understand why someone is selling and how that can be beneficial for them, so you can have a win-win outcome.
That is the key piece that can’t be overlooked. The second thing would be making sure that you don’t silo parts of acquisition by handing over the diligence process to the integration team without including them in anything prior to making an agreement.
Thanks to Scott Hile for sharing his M&A experience with us. Scott is the owner of Stamm Collaborative, an M&A and strategic advisory firm, with principles in South Caroline, Texas, and Germany. For more information, visit thestamm.com.
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