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How to Identify and Deal with Issues During Diligence in M&A

Kison Patel

Kison Patel is the Founder and CEO of DealRoom, a Chicago-based diligence management software that uses Agile principles to innovate and modernize the finance industry. As a former M&A advisor with over a decade of experience, Kison developed DealRoom after seeing first hand a number of deep-seated, industry-wide structural issues and inefficiencies.

CEO and Founder of DealRoom
"The idea, coming out of it, is to have a stronger business case in terms of your ability to achieve your goals and minimize any potential risks."

How to identify issues during diligence

On this episode, Kison interviews Jeff Desroches, VP of Corporate Development at Atlas Copco, about how to identify issues during diligence in M&A. Jeff is a high-impact Corporate Development executive adept at identifying, developing and executing strategic growth opportunities.

He’s a resourceful problem solver with proven ability to manage large, cross-functional teams to drive complex commercial and technical programs with extensive experience in international dealmaking.

Together, Jeff and Kison discuss approaches to take for deal negotiations, how to present an offer and prepare yourself for any responses you may get, and what the main priorities of diligence are. They also cover topics such as issues that commonly appear during diligence, how to deal with those issues, and Jeff's opinion on culture.

"Think about what the main priorities are of diligence - It's to verify all the assumptions and all the information you got before you get to the diligence phase, and then secondly to minimize your risks."

One of the other priorities of due diligence is an efficient data gathering itself. Ongoing company operations involve masses of data. But how can you ensure accurate and safe data analysis and reporting for M&A due diligence?

You can gather relevant sales and profit data through by investing in reliable, advanced hardware and software systems to create accurate reports for due diligence. 

For instance, inventory management system can be useful in M&A due diligence by providing insights into the target company's inventory levels, stock movement, and potential inventory-related risks. These systems help business monitor and maintain stocked products, including raw materials, company assets, and finished products. This business tool serves as a point of reference and a centralized inventory database, allowing data analysis, report generation, and demand prediction.

Other examples may include diligence management tools like DealRoom which simplifies and streamline the diligence process for all the parties involved into the deal.

Show notes

0:00 Introduction

1:18 Jeff's role

3:38 Approaches to strategy

6:24 Presenting an offer

7:21 Main priorities

8:31 Issues that come up in diligence

10:20 Surprises in diligence

13:30 What causes friction

16:34 Cultural assessments

25:16 Being conscience and lessons learned

27:31 Craziest thing Jeff's seen in M&A

30:00 Closing remarks and end credits


Text version of interview

Can you start by briefly explaining your role at Atlas Copco?

I primarily focus on driving inorganic growth. I work closely with our business leaders to develop strategies for how they want to grow their business. Those strategies tend to take both organic and inorganic sub-strategies, where I typically drive the inorganic strategies, and this includes everything from mergers and acquisitions to joint ventures, strategic collaborations, licensing, as well as divestitures. 

What are some of the approaches you take when it comes to deal negotiation strategies?

I use empathy as a tool early on in the process. When I am approaching middle or lower-mid market owners of businesses I try to put myself in their position and try to understand what their vision and needs are and what they are looking for out of a potential deal. This helps you position yourself well and appeal to an owner. 

You need to keep in mind that it might be the only time these owners have ever had any exposure to the M&A process, so they will likely have a lot on apprehension about how the process is going to work, what they can expect, or how much money they are going to get. When you understand this you can find a way to appeal to all those different priorities they may have. 

How much do you present in an offer and prepare yourself for responses you may get?

A very common response is to lower the price. By using the tool of empathy, you can try to position yourself so that it’s not just based on price. This is one of the distinctions in approaches I believe exists between corporate strategic and private equity. We are not just looking to get the deal and buy the business, but we try to be good stewards of their brand, facility, and people as well. 

Getting the dollars isn’t necessarily the most important thing that the owners are looking for and there are a lot of different levers that you can pull. We are trying to keep a multi-brand approach, find good business, and then try to invest in them. We want to hire more people, build more facilities, invest more resources, and grow it.

What are the main priorities of diligence? What should be the goal for the outcome?

As you are transitioning into the diligence process and trying to build a collaborative environment where you are aligned with your seller on what the mechanics and the goals of the process are, it’s important to think about the main priorities of the diligence process in general. 

Primarily, it’s important to verify all the assumptions and the information you got before, and secondly, it’s perhaps even more important to try to identify and minimize your potential risks going forward, so you can successfully execute the business plan. Those are the two main goals. When you are coming out of that process, the idea is to have a business case that is strengthened and has a strong foundation in terms of your ability to achieve those goals, where risks are minimized.

What kind of issues have you seen come up during diligence?

When dealing with mid and lower-mid market size, the common one you’ll see during diligence is that accounting practices aren’t as sound as larger companies might employ. We see issues with inventory management, as smaller business owners don’t always appreciate the amount of capital they’ve got tied up in that inventory. It’s either overvalued or they’ve got a lot more than they really need to run the business efficiently.

Another one would be related party transactions, where many owners I come across own real estate through separate LLCs and they will have lease agreements or, in some cases, have no lease agreement. The seller needs to be completely open and honest about these things.

What were some of the unexpected things you found in a diligence process?

It’s not uncommon to have family members in the business and if you find a business where 30 or 40 percent of it is owned by family members, so you need to think about how you are going to manage that going forward. If you do an integration of the company and you want most people to stick around you really need to be aware that an issue happening in one part of the network is going to affect all the rest of it. That’s a surprise that can be challenging sometimes. 

One time we purchased golf membership along with a company because we found out that club memberships are appreciating assets.

What’s a surprise you found that killed the deal?

We’ve had a number of litigations come up. The seller’s view of how critical litigation might be versus what we view is a bit different. All of the mentioned risks are manageable, so it’s just a question of how much risk you are willing to take on and do you have mitigation strategies.

Do you think the mechanics of diligence or the unexpected issues caused more friction during the diligence process?

The mechanics are sometimes, for me, a bit easier to deal with in the sense that I can work with the owner and our team and try to minimize the impact on their business. The unexpected issues are a bit of an unknown by definition. Fortunately, we’ve been lucky that we’ve run into very collaborative, honest, and upfront sellers, so we didn’t have to deal with too many major surprises. 

What’s your approach for handling those unexpected issues?

Every deal has some issues. You want to make sure you pull in whatever experts you need to address that particular issue or issues. Putting is off or minimizing it is a recipe for disaster. Take all the issues seriously, even if they are minimal, make sure you address them and if you need a mitigation strategy you need to go ahead and develop it. 

Over the past few years, I have heard a lot about the importance of culture, yet I’ve never heard of anybody who walked away from a deal because of culture. I am curious to hear your views on that.

Culture is critical, however, I don’t know that the M&A process has matured enough to try to improve the way it assesses and manages the culture. I think a lot of the data that you see about integrations being the primary reason for the failure of deals or deals not meeting their origins objectives is because of the poor cultural fit that gets discovered only once the rubber hits the road in the integration process. 

This is not to say that there aren’t things like cultural mapping or assessments, but I think there is still a lot of subjectivity in that process and those assessments. I think there is still a lot of space for improvement in that arena. It’s tricky because it’s not like checking a box on a due diligence list or a valuation model, which is very quantified. This is much more subjective.

What’s the craziest thing you’ve seen in M&A?

Recently, the seller suggested that we do due diligence in his house, where he had a separate building, a man fort, which had a room for a conference, projectors, large bar, theatre, and a gym, so it turned out. That was definitely an inventful and memorable diligence process. 

Are there any specific types of investments that we would run from?

There’s probably more of those than there are ones we would do, which is not uncommon. We work closely with our business colleagues to develop our strategy, but we also have an overall group strategy regarding directions we want to go, and then, within each of the divisions we also have divisional strategies. We use a couple of different sets of tools where we try to define the types of companies that we would find attractive and the characteristics of those companies. We work across several different industries and we have a fairly high operating profitability, so to dilute that very significantly is another potential knock against doing a deal.

There is a whole list of criteria that we have to go through. You don’t have to check every one of them to make a company attractive, but you want to get a plurality of them and you want to see how you can get the company to achieve those other characteristics. 

What is the hardest part of the job?

Corporate development, in general, is a very unique role and it requires some jack of all trades skill sets that you put together. You have to understand how the business works, you’ve got to understand finances and also a little bit about all different aspects of business, such as product development, operating efficiencies, legal aspects of it, purchase agreements, LOI’s and all different terms within those. 

You need to be able to develop your financial models and even to build them according to a template. Sometimes it feels like you are a unicorn hunter who is trying to find companies that fit all of your strategic and financial criteria, which is probably one of the most challenging aspects of my job.

You mentioned that you run your companies as separate brands, and a lot of companies out there will end up integrating, so it seems companies have a very different definition of success.  What is your criteria for defining success on your deals? 

At Atlas Copco, we do a pretty good job of tracking success. We have a set of financial criteria tied to our original valuation model. We look at some of the criteria every month, but we do a more thorough analysis after twelve or twenty-four months to see how well we did against those criteria. We try to do lessons learned after deals after the deal is finished because you want to carry that knowledge forward and avoid repeating the same mistakes. 

We look at lessons quantitatively, but also qualitatively, where we ask ourselves whether or not the business or the product line is playing the role we intended it to play. Profitability and revenue growth are key criteria for us, but all of that feeds into whether or not you are running an efficient operation and managing your shareholder’s capital appropriately. 

How do you take lessons learned and put them into use so that people are conscious of these lessons going into the next deal?

It’s a good thing to see a company that actually does them. We collect the information from the team members and get everyone together to talk about what they have learned instead of having them emailing their comments, so there is a synergy that happens among people. 

Once you’ve done a few acquisitions in a particular division or area, you want to take that information out periodically and try to dive into what are some of the common things and lessons learned that you’ve seen and how do they apply to a new deal. We incorporate this as well in our pitch documents and I think that gives some assurance to the ultimate decision-makers.

When a corporation approaches diligence, you are pulling in a lot of different functional leads who are doing their part, looking into the company, and figuring out the value, and they are already busy, running a full-time role. How do you set that expectation?

Resourcing teams can be tricky. We don’t have a centralized team and they are certainly not waiting around for me to give them some more work. However, I don’t find it that difficult to get people interested in doing an acquisition.

It tends to be somewhat different from their daily work and it’s a project-based activity, it’s not a repetitive task, so some people are interested in taking on that new role. Sometimes you have to escalate situations, but most of the time people want to participate and may see it as a compliment to their expertise to be tasked with such projects. 

Resolve due diligence issues in virtual deal rooms 

Identifying and dealing with due diligence issues involves using the right technology. With digital technology advancements, software development paves the way for the creation of virtual deal rooms (VDR).  

VDR is also called a deal room. It’s a secure digital repository to store and distribute documents, which is essential in the due diligence process in mergers and acquisitions. Because mergers and acquisitions involve a massive amount of data with confidential and sensitive information, a deal room is a reliable and safe avenue for all parties to review, share, and exchange documents, as well as tackle due diligence issues.

M&A negotiations usually include lawyers, accountants, and regulators. A deal room provides them with a central communication and collaboration system to resolve issues and reduce errors. For instance, they can access the files in the VDR simultaneously. It’s important to note that VDRs are more secure as compared to face-to-face deal rooms and physical documents, minimizing damage or risk of loss of documents.

Ending credits

Thank you for taking the time to explore the world of M&A with our podcast. Please subscribe for more content and conversations with industry leaders. If you like our podcast please support us by leaving a five-star review and sharing it. M&A Science is sponsored by DealRoom, a project management solution for mergers and acquisitions. See you next time!


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