Dud Diligence: an Acquisition Jack-in-the-Box

This posting is for the C-level executives out there who are doing (or thinking of doing) deals for their small or medium-sized businesses.  It is about helping you prevent form from overshadowing substance. It is about details.  PS: if details bore you permit me to humbly recommend your opting out of the deal business ASAP.

The Merger Verger has seen a boatload of due diligence checklists over the years and found almost all of them wanting, including some that were just pathetic.

Why?  Mostly because they are not written by people who run businesses; they are written by people who advise businesses.

Let’s be honest here: due diligence checklists are about the details, where God (or the devil) is.  A lawyer can make a fine checklist for matters relating to corporate formation or past board meetings and the like; an accountant likewise within his or her purview. 

These lists are fine with respect to ensuring that you get what you pay for.  But when it comes to understanding whether a product is approaching an inflection in its growth curve or whether the production manager knows the difference between a kaizen event and a tsunami, they usually ain’t worth squat.

I was once witness to a classic example of what I refer to as “Dud Diligence.”  Dud diligence occurs when completed checklists become the end rather than the means.  The point is not to merely have the information; it is to use it, to understand it so that you make better decisions about your deal and how to make it succeed.  In this instance, it was a company’s first overseas acquisition.  They had new advisors and placed their own feet on the street only sparingly.

The result?  Boxes and boxes of information that “hid” massive problems in accounts payable, which, when discovered Hoovered major value out of the deal.  I say “hid” because the information was there but a layer or two deep; if anyone had bothered to really explore the documents the evidence would have been found.  But a focus on gathering information rather than on using information left key stones unturned and key problems hidden until it was too late.

Query: Do your due diligence checklists have places to assign the review and analysis of the information gathered or just a box to tick off when the document has been added to the file?  Does your integration process begin early enough for this analysis to be used to recast value or at least get a head-start on addressing the analytical observations?

Query: When a target is forthcoming with the majority of your requests and slow with one or two things, do you pay particular attention to those last ones when they do finally come in?  Or do you let the pressure of an impending closing lead you to assume that they’re fine.  Don’t kid yourself, that delay could have been for a reason.  Find out.

So, what’s the takeaway here?

  1. Due diligence is not about collecting documents; it is about making sure that you get what you think you are buying (that’s the legal and accounting part) and that you understand what you are getting and what to do with it (that’s the businessman part).
  2. Do not be a prisoner of your checklist.  It should be viewed as an aide memoire, nothing more.  It is your job to think about each deal, what you want out of it and therefore what you need to know about the target to make sure you can achieve that.
  3. If your lawyer or accountant provides you with your due diligence checklist, remember that it will probably lack many operational elements that could ensure a more successful deal integration and therefore a more successful deal.  No matter how high-priced your lawyer, you need to do the businessman thinking for yourself.  Otherwise when the deal is done and your advisors are off to their next assignment, you will be left alone with your own private mess.
  4. So the due diligence actually has three activities, not the one activity that most people seem to think it has:
  • Gathering the data
  • Analyzing the data
  • Creating an action plan based on the analysis.

More on point #4 another time.

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