The importance of conducting due diligence before a merger deal

Mergers are a bit like marriages. Very few of them are made in heaven and it takes a lot of hard work in advance to give them a good chance of success. In fact, according to Aswath Damodaran, professor of finance at New York University’s Stern School of Business, about half of all mergers end up in divorce within 10 years of the deal.

Going in with both eyes wide open is critically important, according to BDO transaction services partner Rory O’Keeffe. “Both corporate and private equity buyers need to have clear growth strategy for the future and an equally clear understanding of the role of M&A within it,” he says. “Are they looking at M&A to try to expand markets, win new customers, acquire new technologies or some other reason. You need to know why you’re investing in another business and what you can expect.”

Right fit

This points to the importance of carrying out proper due diligence in advance of any deal. “Buyers need to know as much as possible and knowledge up front is key. Due diligence can take many forms – commercial, tax, IT, operational, HR. The buyer needs to ask all the questions and get all the answers to ensure the target is the right fit before signing on the bottom line. They need to know how the business operates and the key drivers behind its performance. They should look at how it has performed historically, how it was affected by Covid-19, and how the management team responded to that.”

Looking at it from the seller’s perspective, Alan Kelly of Focus Capital says it can often be a challenge for a founder to integrate into a larger corporation. “Going from a position of ‘calling all the shots’ to a position whereby you are now answerable to a new boss can be a culture shock. This can be de-motivating and frustrating and often results in a deal not being optimised. It’s important that a buyer is aware and sympathetic to this challenge.”

These problems can be avoided. “We believe it’s really important that key team members of both the buyer and the seller get to know each other as much as possible during the transaction process so that they all get to discuss and understand their roles and responsibilities post-transaction,” Kelly advises. “Often a hitch in the process can be a positive as both sides get to really know each other when there is an issue.”

Common goals

O’Keeffe agrees, saying that the people aspect is critical to the creation of a successful combined business. “You need to get to know who you’re going to be working with and share common goals. You have to figure out who the key people are and incentivise them to continue to work with you. And you need to look at the people who may not be required or may not wish to continue to work in the business and manage how you deal with them as well. Letting people know their roles and responsibilities post-transaction is key. There should be no ambiguity.”

That personal connection can be quite difficult to achieve in a remote-working environment, according to Kelly. “The ‘fireside chat’ has been a challenge over the past 12 months due to social distancing and the lack of physical meetings. Doing a management presentation over video conference can be effective from a fact-finding point of view but being in a room with the management team, having the small talk and reading body language can’t be matched by video calls. As much time as possible should be invested in the fireside chat as the transaction progresses.”

This shouldn’t hold up the formal due diligence process, however. “Formal commercial, legal, tax and financial diligence should be handled by the advisers on both sides, who should be well briefed to really understand the commercial drivers, synergies and potential impediments of the acquisition,” Kelly adds.