Preventing merger failure: hardening soft due diligence

January 2023  |  FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

January 2023 Issue

Mergers and acquisitions – an enduringly popular form of growth for many companies – can fall short of anticipated objectives for a variety of reasons. According to Harvard Business Review, 70 to 90 percent of merged companies fail to deliver expected results.

When mergers falter, it is not uncommon for fingers to point at the due diligence process. Poor or insufficient due diligence can be the culprit.

Successful mergers require more than a mere comparison of each company’s articulated values or mission statement; acquirers need to explore and examine many aspects of the target’s operations.

Traditional due diligence can be separated into three main categories: legal due diligence, financial due diligence and commercial due diligence. It is important that acquirers pay sufficient attention to all three. This includes key areas such as company overview, financial accounts, consumer base and pending litigation, among others. It allows companies to identify and assess risks, liabilities and business problems early on and potentially avoid losses and a stakeholder backlash down the line.

When pursuing a target, buyers should carry out both ‘hard’ and ‘soft’ due diligence.

Hard due diligence is about collecting, evaluating and verifying concrete data. Legal and financial advisers, for example, will be heavily involved in this process. Experts will gather facts to build a picture of the target company’s status, consulting financial documentation including the balance sheet, financial statements, securities instruments, operational expenditures, and projections, alongside other aspects such as company records, existing contracts, employment agreements, business model and strategy, marketing plans, client relationships, IT structure, and so on.

Soft due diligence, by comparison, focuses on more nebulous concepts, such as people, culture and leadership. According to Investopedia, more than 50 percent of the M&A deals that fail do so because the human element is ignored. While the target’s finances must be in order, it is just as important to understand the people behind the enterprise.

According to McKinsey, the likelihood of meeting cost and revenue synergy targets is substantially higher if culture is effectively managed during post-deal integration. Acquirers should therefore consider the cultural fit of the two companies. Indeed, 95 percent of executives describe cultural fit as critical to the success of integration, notes McKinsey.

Key is to avoid cultural clash, which can have a devastating effect on employees and erode productivity and profitability during the integration period. EY suggests that 75 percent of people in key roles quit within three years, on average, post-merger.

An organisation’s culture, perhaps the most important of the ‘soft’ subjects within due diligence, is reflected in its values and practices. The ability to align philosophies between the merged companies will impact the collective organisation’s ability to deliver value to customers, stakeholders and employees, and could ultimately decide whether the merger will succeed or fail.

Culture is complex, multilayered and difficult to pin down. But analysing it can help executives identify the qualities that must be maximised and protected.

Due to its intangible nature, conducting soft due diligence can be more challenging than hard due diligence, as it means assessing people, principles and ethics rather than raw numbers or binding contracts.

There is no ‘one size fits all’ approach, but acquirers can take steps to gain revealing insights into corporate culture.

To fully realise the benefits, cultural due diligence should be conducted early in the dealmaking process. It should consist of a cultural assessment that highlights areas of similarity and divergence which may impact integration efforts and the ability to achieve the company’s strategic objectives in the long term.

The due diligence team should focus on gathering information on the target entity using public and informal sources, as well as first-hand observations of culture from various viewpoints, and then examine and validate this data.

A thorough cultural review can help companies create an aligned vision for the company post-close, laying the foundations for an integrated internal culture that supports overall business strategy, thus setting the company up for success.

Once the acquirer has an understanding of the culture, it can develop the most effective means of communicating with employees and establish effective leadership teams. Senior leaders will need to be aligned on key cultural traits, to reinforce a corporate culture that supports the company’s priorities.

Given the financial and reputational consequences of a failed deal, companies must take all possible measures to know the target company inside-out. Soft due diligence can make all the difference.

© Financier Worldwide

BY

Richard Summerfield