A thorough, smart and stealthy due diligence process is among the top ingredients for successful mergers and acquisitions. We spoke to finance executives and dealmakers about the homework a growth-hungry company needs to do. “Prepare, ensure all parties are on the same page and don’t get distracted by unnecessary details,” advises Dr Andrew Balnaves, Executive Vice President of Africa Corporate Finance at Standard Bank.
By Toni Muir
"Properly conducted due diligence might uncover hidden gems," says Andrew. "If you uncover something in the due diligence that you weren't aware of, that is a huge upside that you haven't previously understood and makes the whole process more attractive."
According to Andrew due diligence is "a professional and well-understood process" that should run smoothly. "Before you get started, consider why you are pursuing the transaction and identify which key metrics need to support the investment thesis," he advises. "Plan and prepare, get clarity on the expectations of both sides, and ensure the counter-party is on the same page as you."
It is also important to enter a deal with a focussed mind, he says. "To this effect, you should know what your investment proposition is. Your due diligence should be aligned to this and tailored to suit the needs thereof."
He cautions against cultural or expectation mismatches, which he says can curtail a deal because the two parties end up frustrating each other. In this regard, expectations are extremely important, he emphasises, as is ascertaining the commitment of the other party before the process kicks off. "You don't want to open your books to someone unless they are a credible party and they're highly likely to execute the transaction," he says.
Materiality
Andrew's experience of deal making has given him insight into the different stages thereof, what works and what doesn't. For instance, people often get "too bogged down into the details," he says. "You need some guidance on what the level of materiality is and what is really driving the business. Often, you will have very excited external advisors or technical advisors and they may get drawn into certain elements of the due diligence. You must ask whether this part of the due diligence is relevant to the overall value proposition. You're always a burden to the counterparty in terms of what you are asking for, so you need to ensure the due diligence is appropriate. That's key. You don't want to frustrate the counter-party."
Timing is everything and timelines and deadlines should be agreed upon upfront, he notes. "I would even advocate delaying the due diligence process by a couple weeks if both parties aren't ready," he says. "It might be better to wait and have a shorter process with positive momentum and good lines of communication rather than a stop-start process that frustrates."
Ensuring key items are identified and captured is also important, he says.
"When key items are identified in the due diligence process which might have an impact on the transaction, you need to ensure they are captured somewhere. This might mean you have to adjust the price, change the net debt or working capital adjustments or seek protection in the legal agreements."
100-day plan
While the CFO certainly has a crucial role to play, Andrew doesn't believe they should be overly involved in the day-to-day due diligence process. "The CFO is a busy person and they want to leverage and rely on the financial advisor, especially if it is a large due diligence. That is critical," he says. "The CFO should only really come in at the beginning, for a few touch points at the middle, and then again at the end as the due diligence reports are finalised."
Andrew says the CFO should have an understanding of why the company is undertaking the transaction, and says the scope of work should try to tackle this and ensure there exists a key rationale supported by the due diligence, which can be referred back to. "At the end of it all, you're going to get due diligence reports from various providers. It is important to sit down with your advisors as a CFO and grade those risks, high to low, and ensure they are appropriately communicated to the board, especially where the value proposition is concerned, to make everybody aware of what you have identified."
The due diligence plays an important part in post-deal integration, continues Andrew.
"During this process, the deal captain or CFO should take the key findings of the report and ensure it fits into the 100-day plan. The should also get sign off from the board on how they intend to circumvent any risks or challenges identified in the due diligence report. That must fit into the integration plan."
Backchannel
If you are using a financial advisor, Andrew feels they should take on a project management role, and be a back channel and line of communication between parties. He feels that experts and advisers add value in that they are external to your team, and thus outside of your resources and time. "If you have got a small business development team and a lot of roles and responsibilities, the ability of an expert or adviser to guide those people and run the process for you is critical," he says. "They have got their own expertise and they may identify elements that you may ordinarily not identify. They should be advising on how to mitigate recognised risks. You can leverage the combined experience of advisors and a technical team to support your deliberations."
For larger deals, Andrew recommends employing the services of a financial due diligence provider - by way of a professional services firm - to handle all financial and tax due diligence.
"If you are moving into a new market you might consider undertaking commercial diligence. Technical support may also be advisable for industries like mining or where IP or technological processes are central to the value proposition."
As far as technology is concerned, Andrew says the advent of the virtual data room and digital disclosure of all the discussions, questions and documents has radically changed the way due diligence and deal making is done. "It also mitigates some of the disputes that could arise post-closure," he says. He says that some of the financial steps, the auditing and analysis, will be more automated and less human. "I foresee less physical inspection of accounts and, though this is perhaps five or ten years way still, blockchain accounting could play a huge role."
Andrew's due diligence top five:
- Prepare and define the scope of what needs doing.
- Communicate with the counter-party what you intend to do.
- Keep to a tight, agreed time frame and maintain momentum.
- Ensure key findings are disclosed in the board pack and integration plan, and are factored into the price and other adjustments.
- Be flexible and maintain an open mind so that if things change in the process, you can be agile where you need to be.
This article first appeared in CFO Magazine.
