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. “Ideally, the CFO shouldn’t only focus on the financials, there needs to be a cross-over. The CFO, along with other execs, can really help to join the dots in a deal,” says Charles Douglas, head of M&A at law firm Bowmans.
- When dealmaking, enter with a focused mind, says Standard Bank's Andrew Balnaves.
- The CFO should ensure due diligence is accurate and meticulously undertaken, says Sibanye's Charl Keyter.
- In dealmaking, understand what you buy, says Deloitte's Karin Hodson.
- If you want to see deal success, plan, says Ansarada's Arie Maree.
"The best due diligence processes are the ones that are framed by an understanding of the business and the risk - that is the differentiating factor," says Charles. He highlights the importance of translating risks considered and risks identified into the transaction documentation. One approach is to develop things in tandem and get everything in writing, he says. "The CFO is the one who understands the numbers as well as how the business risk translates into the numbers. CFOs sometime don't like, or don't immediately see the value in, going through the long list of warranties or promises about the business, because that is seen as the legal work-stream." This is, however, an important part of the process.
"An optimal situation would be one where the CFO engages on the legal details, guided by the experts, to ensure that what concerns him or her from a financial and risk perspective is catered for in the contractual protections."
Up at night
If you plan to involve outside advisors or experts, Charles says it is important to ensure they are clear on which issues keep the CFO up at night. "It is incumbent on the advisor to ask the questions to try get the scope right. If you make a real effort as a CFO to ensure advisors understand, why you want to do the deal, what is worrying you about the deal, and what the risk issues each advisor should be looking out for are, this will be massively helpful to the process."
Once you start your due diligence you are incurring costs, so you need to know you have got a deal to do before you start getting the various advisors involved.
"It is a stage of the M&A process where the costs rack up quite quickly. It is always a question of what the scope of the work should be. Quite often if it is not efficiently scoped and you can have people doing their jobs, but in a way that is not all that helpful to the company."
Charles notes that, because the CFO has a good understanding of the issues and the risks, it is their prerogative to ensure that contractual protection is a key component of what they are trying to achieve. While you might start with a set of standard warranties tailored to the maximum extent possible, based on the given understanding of the business, the more refined those warranties the better, he says.
An assumption
"What often happens is that you run due diligence and get comfortable with the risks but there is an assumption that risks are adequately dealt with in the contract, for example that your contractual protection is going to work. So, what sometimes happens is that you do the work, you negotiate the agreements and you buy the business, but then an issue comes up. You might check the contract to see how this is covered by the warranties, only to realise the warranties don't quite fit the factual matrix. You are then left wishing you had spent more time thinking about the warranties to ensure they cover everything. That protection is there for unknown risks."
To prevent this, Charles says you have got to make the time for financial and legal to brainstorm together once the due diligence is done and risks are identified, to check if these issues are properly catered for in the contract. "Because, at the end of the day, that is what you are left with - your contractual protection. If it is not fit for purpose you have a problem."
"When it comes to the negotiation of the contract you may seek contractual protection, but have the seller say, 'but you've done due diligence'. Due diligence does not replace contractual protection. Sophisticated negotiators will understand that although it is staged, they need to work together."
So, he says, if you are looking at a target, you want to understand the business by doing due diligence, but you also want the contractual protection, which is essentially a set of promises by the seller. "As a CFO, you really want both - the due diligence you compiled yourself and the set of promises from the sellers."
Charles' due diligence top 5
- Ensure a proper understanding of the business realities and risks so that the due diligence work can be framed up and properly contextualised.
- Ensure that the basis of the engagement is well understood with the target so that the fact that the due diligence is for the purchaser's benefit is understood and does not interfere with the contractual protection.
- Ensure the contractual protection is fit for business purpose so that if an issue arises, the way the contractual protection is framed up works within the context of the business.
- Bridge the divide and know how to make things work if you are moving into unchartered territory.
- Ensure access to and quality of information.
