6 Tips for Superior Due Diligence
1. Account for Human Capital
Mergers and acquisitions fail most often because companies overlook the importance of managing human capital. To ensure the buyer retains the management talent needed, the buyer must communicate future roles early and often with both companies’ employees during the due diligence process.
2. Kick the Tires
A seller’s financial statements provide buyers with information about its assets, liabilities and operations, but reveal little about its quality. A tour of the seller’s facilities can give the buyer a feel for the condition of the plant and equipment and help the buyer determine whether significant capital investments will be required. During the tour, do not overlook the risk of stale inventory and make sure to interview plant supervisors and understand the seller’s returned goods authorization process.
3. Look Carefully at IT Systems
Information is the lifeblood of most organizations and integrating two companies’ information technology systems can be costly. The buyer’s due diligence team should determine whether the seller’s IT system is compatible with the buyer’s system. Do not forget the cost of integrating systems when projecting capital expenditures and obtaining financing.
4. Defuse Financial Time Bombs
Detailed due diligence can reveal hidden costs that may not be apparent from an initial review of financial statements and other documents. Some sellers may attempt to enhance their company’s perceived value by reducing spending on certain functions such as research and development, advertising or maintenance. Downward trends in spending on advertising and other essential business activities can be a red flag. Buyers can uncover deferred compensation practices by analyzing historical salary patterns, obtaining local comparable pay rates and interviewing the seller’s employees.
5. Uncover Liabilities
Hidden liabilities can quickly erase the value of an otherwise promising transaction. Buyers should thoroughly analyze and evaluate potential exposure to environmental risks, employee legal claims and other liabilities and, if necessary, adjust the purchase price accordingly. Interview employees to assess potential liability for wrongful termination, discrimination, sexual harassment or other employment related claims.
6. Analyze Supply and Demand
A company’s future growth depends on its relationships with customers and suppliers, but all too often these relationships are neglected in the due diligence process. Determine why customers do business with the seller. Buyers also should conduct a thorough review of the seller’s supply chain.