Mergers and Acquisition
As a strategic growth strategy, mergers and acquisitions have garnered popularity among companies aiming to venture into new markets, gain a competitive edge, or acquire novel technologies and skillsets. Strategic mergers and acquisitions are versatile solutions capable of achieving diverse business objectives. Whether expanding product lines, securing additional facilities, entering new markets, or gaining access to specialized expertise and intellectual property, M&A can be a powerful tool.
Large corporations are well-versed in the advantages of mergers and acquisitions (M&A), typically focusing on acquiring small businesses to capitalize on economies of scale and achieve cost synergies. On the other hand, digital disruptors have redefined the M&A landscape by acquiring numerous companies to accelerate their growth. This ‘buy and scale’ approach, proven successful, inspires others to follow suit even in challenging circumstances.
Strategic Growth (or Portfolio Builder) Deals
Scale or Consolidation Deals.
Transformational Deals.
Tuck-in
Tuck-in deals are relatively minor acquisitions of businesses that fit into the acquirer’s core business. While the acquirer may be familiar with the target business, thorough diligence is crucial to avoid surprises. This process involves a comprehensive review of the target’s financials, operations, and legal status, ensuring a smooth integration.
Objective
An inorganic growth strategy can be powerful, but it is also challenging and costly. Adopting a buy-and-build approach can reduce the time needed to accelerate growth, develop capabilities faster, and enter new markets. We assist our clients in making this process less costly and more successful and ensuring a smooth integration to make the standalone business successful in the hands of new owners.
What Challenge(s) do Our Clients Face?
- Is the company's growth sustainable? Will the combined entity's earnings be of high quality and sustainable?
- How easily can it be integrated? Which parts of the target's assets will become redundant after the acquisition?
- How can this acquisition be used to transform the entire business?
- How attractive is the market?
- Is the target well-positioned as a stand-alone entity?
- Will the acquirer's customer relationships or capabilities better position the target to succeed?
- Alternatively, can the target's capabilities and relationships do the same for the acquirer?
- How can we measure the health and sustainability of the underlying growth?
- What will motivate employees beyond the management team to remain with the company?
| Buy | Sell | |||
|---|---|---|---|---|
| M&A Strategy | Deal Origination | Strategic Due Diligence | Financial Due Diligence | Post-Merger Integration |
Acquisitions as a Part of a Growth Strategy
In recent years, companies have developed acquisition programs, also known as acquisition strategies. An acquisition program involves a company’s multiple acquisitions to execute its strategy. It differs from conducting several acquisitions in a systematic approach to acquiring companies. The acquisition program becomes a part of the company’s broader growth strategy. It selects the number of acquisitions to conduct, which kinds of companies to acquire, and the timeframes and strategic end-goals of the acquisitions. The table below shows acquisition strategies derived from different types of acquisitions and growth strategies that acquirers can choose from.
| Acquisition Strategy | Acquisition Type | Related Growth Strategy | Acquirer Intention |
|---|---|---|---|
| Market Share Increase | Scale Deal (Vertical Acquisition) | Market Penetration | To increase current market share |
| Cost Reduction | Scale Deal (Vertical Acquisition) | Market Penetration | To reduce production and operative costs (Overcapacity in mature Industries) |
| Competition Reduction | Scale Deal (Vertical Acquisition) | Market Penetration | To reduce competition (in geographically fragmented industries.) |
| Market Development | Scale Deal | Market Development | To accelerate market development |
| Product Development | Scale Deal | Product Development | To accelerate product development (As a substitute for R&D) |
| Diversification | Scale Deal | Diversification | Reducing risk in one’s industry and market by diversification to other markets |
| Market Window | Scale Deal | Product Development/ Diversification | A market opportunity that couldn’t have access without the acquisition. |
Lately, acquisitions have also occurred to exploit eroding industry boundaries by inventing industry application
knowledge.
M&A for Business Unit Strategy and Competitive Advantage
Mergers and acquisitions (M&As) occur at the strategic business unit (SBU) level. At this level, M&A strategies utilize the SBU’s existing business model to establish or gain a long-term, defensible, and profitable competitive advantage by generating strong cash flows. Such competitive advantage-based M&As could rest on two pillars.
Differentiation and growth advantages by:
- Entering new markets (geographies, customer segments, or use cases).
- Getting access to new distribution channels (including direct sales, new outlets, web-based sales).
- Acquiring new products and services that complement the offerings or create cross-selling opportunities.
- Gaining access to new competencies, technologies, or capabilities, like brands, intellectual property, patents, and others, might leverage the acquirer’s core capabilities, like R&D, marketing, or brand management.
Cost advantages that improve operating efficiencies by
- Realizing economies of scale or driving consolidation, Scaling economies of scope
- Leveraging complementary capabilities and assets to achieve efficiency gains
Strategic Rationale for the Deal
Four deal types Understanding the strategic rationale is critical to deciding how we approach the integration process.
Scale/Consolidation
- Increase market share and reduce industry capacity.
- Present a fundamentally similar product offering.
- Create economies of scale
- Full integration: operational alignment, cost synergies
Transformational
- Transformational
- Use deals to transform the way the industry works.
- Create a new value proposition.
- Stand-alone model: business transformation, revenue synergies, phased integration.
Cost Optimization
- Transfer core strengths to target business.
- Enhance or compliment an existing product.
- Leverage buyers’ economies of scale.
- Focus on critical employee retention.
- Full integration: multiply the value of unique skills, eliminate back-office
Strategic Growth/Portfolio Builder
- Expand offering and geographic reach.
- Hybrid integration: skill transfer, reverse integration in some areas.
Due Diligence
The Type of Deals Drives the Due Diligence Process.
Scale Deals. Acquiring a company can create many opportunities for synergy and cost savings. To ensure the deal’s success, it’s crucial to identify and model the potential synergies during the diligence process. This is one of the most critical aspects of achieving deal value. Key things to consider during the diligence process:
- Examine the quality of the target's earnings.
- Consider the target's infrastructure.
- Understand the cultural compatibility between the two companies. Ensuring that the acquired company's culture is compatible with the buyer's culture is essential for a successful integration. This can include evaluating the performance evaluation philosophy, hierarchical vs. flat structure, working hours, and other areas.
Transformational Deals. Transformational deals require a thorough and diligent approach, especially if the acquirer is unfamiliar with certain aspects of the target company’s business. Important considerations to keep in mind:
- Think strategically first and operationally second.
- Be aware of any blind spots that may arise due to unfamiliarity with the target company's sector. Consider bringing in experts to address any sector-specific diligence questions accurately.
- Focus on revenue growth potential. For instance, a life sciences acquirer should verify that the target's R&D capabilities can generate long-term profits.
- Involve the integration team early on to gather the necessary information before closing the deal, ensuring seamless integration and successful outcomes.
- Understand the target company's operational technology to plan or implement a tech strategy effectively. During the diligence process, operational technology emerged as one of the top two most influential factors in deal value.
- Use technology to expedite analysis. Given that these are large-scale deals, diligence should be supplemented with tools and technology to improve the efficiency of analyzing large data sets and uncovering better insights quickly. The use of analytics has become a standard practice for leading acquirers.
Tuck-in. In smaller transactions such as tuck-ins, operational diligence becomes particularly important as these deals often require more fixing and investments than acquirers realize. For instance, when acquiring companies in the personal health and beauty care space, acquirers need to pay more attention to the changes they need to make to R&D, quality, and the supply chain to make these deals work. Even integrating supply chains with different pallet sizes can be costly.
- Validate the deal drivers, including revenue quality, customer retention or attrition, recurring EBITDA levels, and fixed vs. variable costs.
- Identify liabilities or exposure and put protection against these into the purchase agreement.
- Assess the sufficiency of the business operations and determine which areas will require post-close investment.
Strategic Growth. To achieve strategic growth, companies must first identify the areas most likely to provide significant sources of synergy and the “crown jewels” that must be protected. They should then perform commercial diligence to understand how intense the competition is and how well the target can defend its market position. Some critical questions to determine the viability of their growth strategy include:
- How attractive is the market? This question requires an analysis of the market size, growth outlook, cyclicality, and competitive intensity.
- Is the target well-positioned as a stand-alone entity? A well-positioned company should have satisfied customers, stable relative market share, or competitive advantages that can lead to rapid share gains.
- Will the acquirer's customer relationships or capabilities better position the target to succeed? Alternatively, can the target's capabilities and relationships do the same for the acquirer? The synergies can justify a price premium.
- How can we measure the health and sustainability of the underlying growth? This question is critical because the acquirer is likely paying a high multiple on future growth and earnings.
- What will motivate employees beyond the management team to remain with the company? Among companies' strategies to retain talent, demonstrating a career path (73%) and empowerment to make decisions (60%) were the two most frequently cited.
Strategic Due Diligence
- Investment Thesis and Objectives:- When considering new expansion deals, it's essential to evaluate the strategic rationale, assess product and market alignment, determine integration level, and analyze the target's competitive position. When assessing industry consolidation deals, we should focus on potential scale benefits, cost synergies, market penetration, and revenue increases through operating cost reductions and eliminating redundancies. We must also consider customer and competitor reactions and their impact on the integration strategy.
- Market Analysis:- Market analysis must first identify the customer for the target company’s products and services. A practical market analysis will also consider technological, political, regulatory, environmental, and social trends that may impact demand forecasts over time.
- Competitive Analysis:- Competitive analysis involves identifying significant competitors and assessing their strategy strengths. Scoring involves ranking across sub-categories like pricing, selection, differentiation, value proposition, marketing, funding, technology, management team, and reputation. This helps rank competitors and identify best practices for internal analysis. Strategic due diligence involves evaluating competitors' potential responses to the deal, which is crucial for predicting changes in the landscape and crafting response tactics to improve the reliability of the deal’s projected outcomes.
- Internal Analysis:- Internal analysis assesses whether the target company can achieve the desired deal outcomes. We must also analyze the target company's operational capabilities and business model. Identifying best practices through competitive analysis can help assess potential risks and opportunities and create a comprehensive integration plan.
- Risks:- Investors must conduct strategic due diligence to understand a potential deal's risks, benefits, and opportunities. This helps determine if the expected value from a deal is realistic and achievable and can prevent unsuccessful mergers, acquisitions, and investments.
Strategic due diligence is an essential process that can validate a deal’s rationale and significantly improve its chance of success. It achieves this by creating a reliable foundation for formulated post-deal integration strategies.
- Potential synergies and dyssynergies that could impact the deal's success are assessed and validated. Strategic due diligence can also identify potential integration challenges and cultural frictions that can be managed with mitigation tactics.
- When considering new expansion deals, it's essential to evaluate the strategic rationale, assess product and market alignment, determine integration level, and analyze the target's competitive position.
- Strategic due diligence is crucial for assessing a deal's potential and the target company's ability to compete and achieve desired value in the market.
Strategic Due Diligence Hypothesis-Driven Approach
Target has a solid and sustainable Market Position.
- Estimate Market Shares and growth in Market Share
- Map Competitor offerings, Value Proposition, Price
- Net Promoter Score
- Understand Customer lock-in, Switching Costs
Evident Growth Potentials in the Target’s Core Business
- Estimate Market Size, Growth and Growth Drivers
- Assess Growth Potential in each Business Segment
- Identify potential growth pockets (Share-of-wallet of existing customers, new customers, and industries)
Target’s Business Plan and Strategy are robust and include upside potential.
- Assess product line growth outlook, including key drivers and limitations.
- Determine how the target can realize the potential of the growth market more efficiently.
- Evaluate the fit of product portfolios vs. customer growth segments and profitability in customer segments.
Target’s organization is set up to Deliver the Business Plan.
- Evaluate management experience and track record in organic growth and M&A growth.
- Evaluate management’s understanding of the market, customer needs, competition, and clarity in value proposition.
Financial Due Diligence
Financial Due Diligence involves helping corporate and private equity clients navigate acquisitions and divestitures to increase value and returns. We aim to expedite deals, reduce risks, and deliver value to stakeholders while quickly returning to normal business operations. By identifying issues early, we help our clients reduce risk.
What is the objective of financial due diligence?
Financial due diligence to ensure that financial information is as accurate as possible. This is critical for buyers to ensure that the deal delivers what is promised. From a sell-side perspective, it helps ensure that management presents financial information to potential buyers as transparently as possible.
- Identifies and focuses on business factors critical to the target company's future success. It also ensures that governance and risk management objectives are met.
- Diligence is necessary because sellers often present the company in the best way to increase its value.
- In many cases, acquisitions are valued as a multiple of EBITDA, and management may adjust the EBITDA presented to buyers to exclude certain expenses or reverse accruals (increase to EBITDA) in anticipation of a sale.
- Diligence is designed to uncover unusual trends and non-core transactions to arrive at "normalized" or "run rate" EBITDA. Buyers often remove such items from EBITDA, which may reduce the purchase price.
- Diligence procedures help identify significant issues, risks, and opportunities. For example, they can uncover revenue, margins, and earnings concentration in specific geographies, customers, and product lines and purchase supply agreements with a parent or other related parties.
- It focuses on earnings, cash flow, non-operating income, reliance on specific suppliers or customers, potential synergies, carve-out issues, debt-like items, future cash requirements, and working capital requirements.
- Financial diligence focuses more on earnings and cash flow than audits and may reveal adjustments that could inflate earnings and the purchase price.
- For private companies, interim internal financial information may not include significant year-end audit adjustments and may mislead monthly trends.
Financial Diligence Focus Area
Investigate Valuation Considerations
- Quality of earnings
- Identify unusual or non-recurring adjustments
- Significant operating and financial trends, Bridging operating periods
Analyze the Technical Application of GAAP
- Understand the accounting implications of a potential deal
Gain Understanding of Business, Operations, and Balance Sheet
- Working capital and other purchase price adjustment mechanisms
- Treatment of debt and other liabilities
- Conduct of business between signing and close, Regulatory issues
- Representations and warranties, indemnification provisions
Deep Dive – Quality of Earnings
Quality of Earnings drives Earnings Before Interest, Depreciation, and Amortization (“EBITDA”), which typically has a direct impact on deal value
Why is it important?
- QoE analysis identifies potential adjustments to EBITDA, which can directly affect price, financing, and other value considerations
- Other QoE analyses: organic vs. acquisition growth, significant lost customers, customer concentration, FX impact
- Understand operating performance and cash flow, including amounts available for debt service
Other Quality of Earnings Considerations
Other items that impact the quality of earnings but may not be included in adjusted EBITDA include the following.
Financial Reporting and Process, Revenue growth Assumptions, External factors, Cost Assumptions, compensation Expenses Analysis
Working Capital and Cash Flow Considerations
Analyzing working capital, especially in capital-intensive industries, can significantly impact financial due diligence.
Working Capital Due Diligence
- Identify trends – seasonal swings, unusual ‘bubbles,’ and management ability to manage balances
- Normalized items (one-time reserve reversals, true-ups, etc.)
- Peak/trough analysis (cash needs)-impact on financing considerations (e.g., size of revolver)
- Purchase agreement definitions
Working Capital Management
- Understand how management manages and analyses working capital
- Identify and calculate WC ratios (CCC, DSO, DIO, DPO)
- Assess Target’s ability to manage WE through deferring payables or accelerating receivable collections.
Seasonality
- Understand how seasonality impacted historical results
- Improve forecasting of cash flows
- Appropriate structure for any purchase price adjustments or earn-out mechanisms
- Determine the magnitude of required revolving credit facilities
- Intra-month variability- in addition to seasonality. There may be variations within a month.
Peak-Trough Analysis
- Analysis that schedules when working capital is at the high and low points during a period
- Consider borrowing capacity under revolver to have enough financing capacity to consider WC swings.
Post Merger Integration Support (PMI)
The approach to diligence and M&A integration should be tailored to each deal, as every deal is unique. Using the same playbook for all deals can be detrimental to the value. Companies must assess how the agreement aligns with their overall growth strategies and take a comprehensive view of due diligence and integration steps that align with the deal rationale.
When conducting strategic growth transactions, it’s crucial to focus on revenue growth and integrate critical business areas early, such as regulatory, compliance, financial, accounting, compensation, and benefits. The integration of back- office regions depends on the acquirer’s operating models and target. Commercial aspects like sales, marketing, and customer strategy are vital capabilities that led to the deal and should be fully integrated.
Integration priorities are more easily identified when a clear integration strategy is defined and communicated.
Acquisition Strategy
- Acquire New Products and Services
- Open New Markets and Distribution Channels
- Acquirer Key Talent (People)
- Obtain Key Assets and Capabilities
- Consolidate business
- Acquire New Business Model
Integration Strategy
- Define a product roadmap, develop a marketing plan, align sales and partner channels, train the sales force, and align the compensation system.
- Negotiate distribution agreements, consolidate supply chain operations, and align sales and partner channels.
- Assign staffing roles, define retention plans, and integrate compensation, health, and welfare.
- Align operating policies, procedures, and processes, secure assets
- Rationalize facilities and headcount, merge financial systems, and drive procurement synergies.
- Define and communicate new directions.
Integration in different types of deals
Scale/consolidation
- The Large-scale nature of the acquisition requires more bandwidth from top management and resources to execute the integration.
- There are potential ramifications on all aspects of the value chain.
- Full integration: operational alignment, cost synergies
Transformational
- A new organizational structure that affects individual organizations’ existing processes and value chains is determined.
- Much longer-term integration needs to be executed.
- Stand-alone model: business transformation, revenue synergies, phased integration.
Tuck-in
- The target’s critical assets are absorbed into the acquirer’s current operation, requiring limited integration.
- Select processes are absorbed while others are discarded depending on expected value.
- Full integration: multiply the value of unique skills, eliminate back-office
Strategic growth/portfolio builder (Bolt on)
- The acquired company is purchased but continues to operate as a portfolio company with independent processes and structure.
- This is possibly due to the overall corporate strategy, nature of products and services provided, brand image, etc.
- Hybrid integration: skill transfer, reverse integration in some areas.
- Strategic growth transactions or portfolio builder. In strategic growth transactions, it’s essential to pace integration. To understand performance drivers, leave critical business aspects separately for two to three years. Early integration is needed for regulatory, compliance, financial, and accounting requirements and compensation and benefits decisions. Back-office integration should align with the acquirer’s operating models, while commercial aspects like sales and marketing usually need full integration.
- Scale or consolidation deals. A significant portion of the value in scale or consolidation deals comes from synergies. The integrating teams must understand the current revenue and cost structures and their future outlook to achieve these synergies. Synergy estimates often fall short because the team needs in-depth knowledge of the actual recurring earnings of the businesses, individually and combined. To avoid issues, companies should capture synergies early in the integration process and aim to achieve 60% to 70% of the target within 12 months post-close. Consolidation deals allow eliminating redundant entities, cutting costs, and gaining quick wins.
- Transformational deals. The integration process in transformational deals can take three or more years. Companies should focus on immediate cost synergies and prioritize identifying cost-saving opportunities in both the target and acquiring companies. Sharing a clear and long-term strategic vision with employees and stakeholders is vital for alignment. Remember the strategic rationale for the deal and the integration plan throughout the process to achieve the transformational goals and create long-term value.
- Tuck-in deals. In tuck-in deals, it’s crucial to involve the business units of the acquired company quickly. While these deals usually involve complete integration, except for marketing and creative aspects, it’s essential to recognize that each deal is unique and needs a tailored approach. Using a one-size-fits-all playbook can be detrimental. Companies should assess how a deal fits into their growth strategy and align due diligence and integration steps with the specific rationale for the deal to maximize potential and ensure success.
Integration focus commences with a strategic rationale. During the diligence stage, the integration thought process begins to take shape.
Strategy & Screening
- Strategic Rationale
Initial Negotiation
- Strategic Rationale
Diligence
- Validate assumptions for doing the deal
- Size and verify the value and timing of synergies
- Highlight risk to the combined business case – uncertainty of assumptions and implementation risk
Integration Planning
- Develop plans to achieve the business goals/objective and seamlessly operate ‘day one’ as a combined entity
- Identify and gain commitment from accountable owners for future results, such as synergy attainment and ongoing business performance.
Integration
- Convene, monitor, and manage the teams to implement the plans to obtain the business rationale objectives
- Track decisions progress and ensure teams capture the identified synergies
100 Days & beyond
- Maintain accountability at the business leader level for capturing synergies
- Maintain accountability for delivering the business results per the strategic rationale
- Measure results to the business rationale baseline
- Elevate/improve performance to the next level where gaps over competition exist.
Synergy
A key factor for successful integration.
Mergers and acquisitions can be business game changers but are not without challenges. One critical factor determining the success of such deals is the ability to achieve synergies—the sources of improvement in earnings or cash flow that emerge when two businesses merge.
Synergies come in different forms, such as recurring revenue, cost, and balance sheet synergies. They represent the potential for value creation that exceeds the sum of the parts for companies. However, achieving synergies can be challenging, especially in realizing revenue synergies, which requires persuading customers to continue or expand their relationship after a merger.
Revenue Synergy
Revenue synergies are crucial to successful deals but can be challenging due to internal and market factors. Focusing on top-line growth and developing a solid plan to capture revenue opportunities is essential. Eight levers can deliver revenue synergies and bring more structure and discipline to this basic value source. This guide helps categorize revenue synergy opportunities within a value chain for better insights. Opportunities closer to the customer have higher potential. Assigning levers like market growth, customer proximity, and competitor response enhances these insights.
- Market growth is crucial to survey the commercial landscape before assessing the elements within the buyer’s control. A high-level assessment of market conditions, such as maturity and growth prospects, will inform the probability of success.
- Proximity to the customer can be mapped to one of the four typical value chain components. The further away an opportunity lies from ‘the customer,’ the longer the likely lead time required to realize the synergy, the higher the risk, and consequently, the lower the probability of a successful outcome.
- Control of value source is essential. If control of a value chain area resides with a third party, there is less control and oversight across the lifecycle, which generates risk. Opportunities with lower complexity demonstrate a higher probability of success.
- Competitor response is a crucial determinant of success. If success is achieved through realizing revenue synergies, competitors will try to emulate it. The credibility of the buyer’s response to that emulation will inform overall risk.
- Proven delivery capability is necessary. Great opportunities can only be realized with experienced people turning them into reality. The ‘experience curve’ is a well-trodden path, and there is extensive research to demonstrate that serial acquirers tend to embed an enduring integration capability.
The importance of synergy detail reliability and the digital aspects of an opportunity cannot be overstated. Assessing the quality of digital assets, such as customer databases, is essential. To realize an opportunity’s potential, look for deep customer information, effective segmentation, and high customer engagement.
How Do We Capture Synergies?
Before a merger, due diligence must provide a clear roadmap for capturing synergies and creating value. It typically concentrates on fair market value rather than exploring critical sources of additional value offered by synergies between merging companies.
Companies should explore new ways to maximize value with the newly acquired asset. Reference @ Mckinsey, has a framework to guide this effort and help companies find opportunities that exceed due diligence estimates by 30- 150 percent.
The framework defines three layers of value creation:
- Protecting the base business: preserving the pre-merger value and maintaining the core business.
- Capturing combinational synergies: traditional value creation efforts that aim to achieve economies of scale and enhanced efficiency.
- Seeking to select transformational synergies: often ignored but capability-based opportunities to create value by radically transforming targeted functions, processes, or business units.
Within each layer of value creation, there are three levers that companies can use to realize value:
- Cost: eliminating redundancies and improving efficiencies to capture cost savings.
- Capital: reduce working capital, fixed assets, and borrowing or funding costs to improve the balance sheet.
- Revenue: acquiring or building new capabilities that enhance revenue growth (e.g., cross-fertilizing product portfolios, geographies, customer segments, and channels).
Cost, capital, and revenue opportunities vary by value creation layer. However, mapping the full range of opportunities reveals the entire landscape of synergies that a merger might tap to create value. (See the sidebar on the four types of synergy targets.)
Acquiring a business is a challenging task. According to McKinsey research, companies that acquire other firms tend to experience an eight percent decline in sales in the quarter after announcing the deal. However, companies with substantial merger experience can avoid this pitfall by focusing on the following areas:
- Keeping the business running smoothly by ensuring accountability for current-year results and making necessary investments to maintain quality.
- Separating integration efforts from day-to-day operations, with integration managed by a dedicated office staffed with experienced professionals.
- Shorten the post-announcement period and announce the new management team as early as possible.
- Retaining customers and necessary talent through shared aspirations, clear communication, and appropriate incentives.
Despite their experience, companies must focus more on achieving due diligence targets and protecting the base business to avoid neglect or missed opportunities. By doing so, the combined company can profit from day one.
Capturing synergies in a merger or acquisition can be challenging. Most companies focus on cost and capital synergies but may overlook revenue synergies, representing growth opportunities.
Revenue synergies are often more valuable than cost and scale synergies and deserve immediate attention during merger planning. Neglecting them initially can delay their realization by a year or more.
Frequently Asked Questions
Strategic Due Diligence- Strategic due diligence considers what competitors may do in response to the deal.
- Without strategic due diligence, investors will unlikely fully understand a prospective deal’s potential risks, benefits, and opportunities.
- Strategic due diligence can validate a deal’s rationale and substantially improve its likelihood of success by creating a solid platform from which post-deal integration strategies can be formulated. Potential synergies and dis synergies that could impact the deal’s success are assessed and validated.
- Strategic due diligence can also identify potential integration challenges and cultural frictions, which can be hedged with mitigation tactics.
- Strategic due diligence is critical to unlocking a deal’s full potential.
Perhaps one of the most frequently asked questions, due diligence can take 30 days to 6 months. The length of time will vary by company type, size, and the complexity of the potential deal. There is no perfect answer. It also depends on the deal types, such as Tuck, Scale or consolidation, Strategic growth or portfolio builder, or transformational. These types also decide the nature of the integration strategy. However, the benchmark processes, expert knowledge, and leveraging of network associates are crucial in understanding the deal early and closing it as soon as possible.
Conducting due diligence is essential to understand what you are buying and to establish a clear picture of the fundamental value of the business, i.e., the main upsides and risks. In summary, understand the target business, the market, and the customers; identify strengths and weaknesses and the competitive position of the business; identify improvement opportunities (stand-alone); identify and understand critical risks; identify possible synergies and how to run the company, prepare for successful negotiation and acquisition.
Due diligence helps investors and companies understand the nature of a deal, the risks involved, and whether the agreement fits with their portfolio. Due diligence lets buyers identify cost savings and other synergies from mergers or acquisitions. Various types of due diligence play defined roles, such as strategic due diligence, which focuses on the business’s future potential. Financial due diligence evaluates the current financial position to arrive at the price and future upside possibilities to determine if any premium is to be applied to the deal; commercial due diligence about the customer target model, revenue models, similarly supply chain due diligence, legal, due diligence, and IT due diligence.
Frequently Asked Questions
Financial Due DiligenceTo increase value and returns, help corporate and private equity clients navigate acquisitions and divestitures transactions. Assist with various transactions, from small and mid-sized deals to the most complex ones, including domestic and cross-border acquisitions, divestitures and spin-offs, capital events such as IPOs and debt offerings, bankruptcies, and other business reorganizations. Allow our clients to expedite deals, reduce risks, and capture and deliver value to stakeholders while quickly returning to business as usual. Reduce risk by identifying issues early.
Buyers perspective
- Ensure financial information is as accurate as possible
- Identify and focus attention on business factors critical to the target company’s future success
- Ensure governance and risk management objectives are met
- Sellers will present the Company in the best possible way to increase value.
- Often, acquisitions are valued as a multiple of EBITDA. Management may adjust the EBITDA presented to buyers to exclude certain expenses or may reverse accruals (increase to EBITDA) in anticipation of a sale.
- Diligence is designed to uncover unusual trends and non-core transactions to arrive at “normalized” or “run-rate” EBITDA. Such Buyers often remove items from EBITDA, which may reduce the purchase price.
- Diligence procedures help to identify significant issues, risks, and opportunities, such as Non-operating income (e.g., reserve reversals, pension “income,” earn-outs), Reliance on certain suppliers or customers , Potential synergies and carve-out issues, Debt-like items, future cash requirements, and working capital requirements
- Certain adjustments (i.e., accrual releases, non-core transactions) may be acceptable for an audit but may inflate earnings and the purchase price.
- Interim internal financial information (specifically for private companies) may not include significant year-end audit adjustments and may make monthly trends misleading.
- The sellers usually present buyers with projections. These projections may be aggressive and not consistent with historical results and trends (i.e., the “hockey stick” trend).
- Diligence helps bridge historical results with projected and forecasted results.
Seller’s perspective
Apply the buyer’s perspective to identify value drivers and potential deal issues before the buyer is due diligence
- Prepare detailed analyses of the quality of earnings, risks, and opportunities for the forecast and normalized working capital on a consolidated, legal entity, and product line basis, as applicable.
- Prepare Clients for buyer due diligence process – strategically and organizationally
- Leverage business knowledge to help prepare clients’ “go to market” strategy.
- Advise and assist in assessing information to be included in the data room and improving data integrity.
- Advise and assist with accumulating data and reconciling schedules to help ensure potential buyers understand how the data holds together
- Advise and assist in responding to buyer questions throughout their diligence process to help ensure continuity and reduce management distractions.
- Leverage knowledge obtained during diligence to take the preliminary pass at addressing potential buyer questions.
- Advise on transaction structure, vital sales agreements, and negotiation issues.
- Assist in identifying negotiating positions on items such as working capital targets. This helps ensure positions are fully understood and vetted to increase the likelihood of achieving an advantageous result in negotiations.
- Develop a tailored data room index covering financial, tax, and employee benefits
Financial due diligence has the primary objective of establishing and understanding a target firm’s actual financial situation in the past few years (in most cases, around three years) and forecasting its future financial situation. This is the basis for the acquiring party’s current valuation of the target firm. For strategic investment decisions, as well as for providing a foundation for formulating a post-acquisition business plan and integration program, the target firm’s internal control and the actual situation of operational management must be initially understood.
Preparation, research, verification, and analysis. Preparing a checklist helps drive efficiency, speed, and focus. Research involves various information, interviews, and reports. Verification, for example, involves a deep dive into the quality of earnings.
Analyzing how this business has done historically, what if future projections, what are the key sources of value creation, and what are the risks? What is my downside investment case?
Deep Dive – Quality of Earnings
Quality of Earnings drives Earnings Before Interest, Depreciation, and Amortization (“EBITDA”), which typically has a direct impact on deal value
- Quality of Earnings analysis identifies potential adjustments to EBITDA, which can directly affect price, financing, and other value considerations
- Other quality of earnings analyses: organic vs. acquisition growth, significant lost customers, customer concentration, FX impact
- Purposes of Quality of Earnings Analysis
- Understand operating performance and cash flow, including amounts available for debt service
- Identify items to be considered in determining the company’s financing EBITDA and resulting leverage and interest coverage ratios
- Identify items to be considered in determining historical EBITDA numbers for modeling/valuation purposes
- Bridging operating periods and understanding variances/drivers of change in the business
Below is a basic outline of the financial due diligence checklist:
- Income statements (past five years) showing income and expenditure, profit and loss
- Balance sheets (past five years) showing company assets and liabilities
- Cash flow statements (past five years) showing all cash inflows and cash outflows
- Management discussions around financials, including meeting minutes and emails
- Operating margin, reflecting the percentage of profit the company produces from its operations before subtracting taxes and interest charges
- Gross margin (amount of money left after subtracting all direct costs of producing or purchasing company goods or services)
- Profit margin, i.e., net income divided by net sales or revenue
- Interest coverage (earnings before interest and taxes divided by interest expense)
- Debt to equity ratio, showing how much debt there is compared to assets
- Asset turnover, showing how many sales were generated from every dollar of company assets
- Return on assets, showing the level of efficiency in earning profit from company resources
- Return on equity, i.e., net income divided by shareholder equity
- Tax due diligence, showing direct and indirect taxes the company is liable to pay
Frequently Asked Questions
M&A-Integration supportTherefore, M&A advisors are crucial in guiding businesses through the complexities of mergers and acquisitions. They provide valuable expertise, strategic guidance, and support to ensure that buyers and sellers achieve their desired outcomes in the transaction.
Synergy is one of the critical aspects of M&A. Identifying synergy in predeal and steps to capture and deliver the same post-deal, i.e., during the integration process, requires smooth execution—external advisors. Advisors augment a company’s internal capabilities, provide access to targets, and support as needed. External advisors, who could be experts, also understand how complex processes are helpful during the integration.
Determine the value drivers, guiding principles, and mergers and acquisitions integration strategy. Appointing and supporting the right leaders, team, governance structure, and activities are critical to capturing M&A deal value. M&A integrations can often be highly complicated due to the level of interdependencies throughout the entire organization, and successful ones require a unique set of resources and skills that may not be built into an organization’s core operating model. Appointing a leader with the right skills to manage complex and fast-paced M&A integrations can help organizations realize the total value of a transaction. A typical M&A integration timeline should include the following nine phases:
- Vision and mergers & acquisitions integration strategy.
- M&A integration program and governance
- Set up the program, stand up the IMO, and kick off the functional work streams
- Functional charters and Day One vision
- Operating model and organization design
- Business and functional integration
- Drive M&A integration execution and maintain momentum
- M&A value creation and synergies
- Change management and communications
