Pay Me Now, or Pay Me Later – Getting Due Diligence Right

Getting Due Diligence Right
Mergers and acquisitions are the lifeblood of large corporations and PE firms, so conducting a thorough due diligence process and getting valuation right is clearly essential. On a number of occasions over the course of my career, I was handed the keys to run newly acquired companies. And, I can attest to the fact that insufficient buyer optimism is a very rare occurrence!

While I’ve never been a part of a failed acquisition, a couple struggled to fully achieve expectations along the timeline established during due diligence. In both cases, inadequate assumptions regarding commercial synergies, product adoption rates, or operational efficiency were the root cause of the problem.

That is why I am a firm believer that quality due diligence must focus disproportionately on areas that indicate future potential rather than past performance. I like to think of due diligence as a future-oriented super audit that is intended to minimize risk and maximize the overall value of an M&A transaction.

The businesses I ran that met or exceeded expectations, benefited from incredibly good go-to-market due diligence, focused on forward trends, understanding the customers’ buying process, the selling process required to drive adoption, and the best post-deal sales model.

Where there was – shall we say excessive optimism – the link was to misplaced faith in management predictions, unfamiliarity with the market, and unrealistic assumptions about the size of commercial synergies. This can lead to a very ugly downward spiral — Unrealistic acquisition assumptions, which lead to revenue forecasts that are unattainable, that result in a cut in investments to meet profit targets, which causes underinvestment, which hampers a company’s ability to grow revenue.

The cycle then repeats or the outcome forces change in a revenue forecast or there is a new management team. As I said, though no more important than other types of due diligence, go-to-market due diligence is often neglected or done insufficiently.

To borrow the tag line from FRAM oil filters, a company I recently led, “Pay me now, or pay me later.”

Bob Larson