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5 Ways To Avoid M&A Transaction Risks

5 Ways To Avoid M&A Transaction Risks

Show Notes Of Podcast

Here are five crucial steps to take that help prevent M&A transaction risks

  • Follow a framework
  • Build diligence teams
  • Request due diligence materials
  • Collaborate
  • Leverage technology

In 2012, Caterpillar paid $677 million to acquire Chinese firm ERA, a deal which appeared to open up the Chinese coal markets to the US behemoth. Caterpillar Group President, Steve Wunning said of the deal: 

“The joining of these two iconic companies is an incredible combination.” 

But less than a year later, Caterpillar took a $580 million non-cash goodwill impairment write-down on the acquisition.

How could a player as experienced as Caterpillar get it so wrong? 

Let’s acknowledge for a moment that if it happened to Caterpillar, it could happen to anybody.

The literature on M&A is awash with advice on the importance of preparation in successful transactions but even that doesn’t guarantee that a deal will be a success. 

The broad nature of M&A is that even if you’ve seemingly accounted for every possible outcome, new issues can spring up virtually anywhere after the deal has closed and destroy shareholder value. 

Some problems are difficult to detect even with the most careful preparation. 

In the case of the Caterpillar deal, ERA had engaged in “deliberate, multi-year, coordinated accounting misconduct” Obvious after the fact, maybe. 

You can’t account for everything. 

The long tail of issues that can arise is too long. And even if you could devote more time to going deeper into those issues, you’d probably be destroying value elsewhere by delaying the deal’s closing time. 

The important part is to take steps that minimize the chances of unpleasant surprises arising. 

In 2012, Caterpillar paid $677 million to acquire Chinese firm ERA, a deal which appeared to open up the Chinese coal markets to the US behemoth. Caterpillar Group President, Steve Wunning said of the deal: 

“The joining of these two iconic companies is an incredible combination.” 

But less than a year later, Caterpillar took a $580 million non-cash goodwill impairment write-down on the acquisition.

How could a player as experienced as Caterpillar get it so wrong? 

Let’s acknowledge for a moment that if it happened to Caterpillar, it could happen to anybody.

The literature on M&A is awash with advice on the importance of preparation in successful transactions but even that doesn’t guarantee that a deal will be a success. 

The broad nature of M&A is that even if you’ve seemingly accounted for every possible outcome, new issues can spring up virtually anywhere after the deal has closed and destroy shareholder value. 

Some problems are difficult to detect even with the most careful preparation. 

In the case of the Caterpillar deal, ERA had engaged in “deliberate, multi-year, coordinated accounting misconduct” Obvious after the fact, maybe. 

You can’t account for everything. 

The long tail of issues that can arise is too long. And even if you could devote more time to going deeper into those issues, you’d probably be destroying value elsewhere by delaying the deal’s closing time. 

The important part is to take steps that minimize the chances of unpleasant surprises arising. 

Here are five crucial steps to take that help prevent M&A transaction risks

  • Follow a framework
  • Build diligence teams
  • Request due diligence materials
  • Collaborate
  • Leverage technology

1. Follow a Framework 

If there isn’t a good answer to the question, ‘why are we going after this deal?’, the chances are that your company hasn’t got a good M&A framework in place. If this is the case, all of the steps which follow below will largely be worthless.

Thus, the first step is to ensure that there is a framework in place which looks at a deal from its conception right through to its implementation and the integration of the target with your own company.

Frankly, this part warrants a book on its own. It encompasses everything from setting a broad acquisition strategy for your firm to follow to how negotiations are conducted.

But the point is, it will be different for every firm, so it’s important that you know what your individual framework is.

It’s hardly controversial to say that having prepared for every step of the M&A journey in detail, you’re less likely to encounter surprises along the way. 

Build Due Diligence Teams

2. Build Diligence Teams

An important second step in the due diligence process is putting together a due diligence team

The team should possess a suitably broad range of knowledge and experience for the deal at hand. While general traits will be common to all teams - expertise in business, legal and financial matters - the best assembled diligence teams are those that are more specific to the deal and the company’s industry. 

The importance of assembling a team with specific knowledge and experience is reflected in the growing popularity of expert networks in due diligence for larger deals. Bringing in an expert may cost more in the short-term, but invariably ends up generating value.

For example, in many cases, a company’s in-house legal time is unlikely to possess adequate knowledge of intellectual property management to provide an informed valuation of the target’s IP. 

The diligence team has an important role to play both before and during the due diligence phase.

Before due diligence has even begun, their role is to generate the due diligence request list (see next item). This is where they can bring their expertise to bear - knowing the right questions to ask. Not only does this minimize the risk of surprises arising, it also gets to the relevant issues faster. 

3. Request Due Diligence Materials

Directly related to putting together effective diligence teams, is compiling the questions to be asked of the target company.

Unless the right due diligence questions are being asked, the right information won’t be forthcoming.

Naturally, this also means omitting pieces of extraneous information that serve little purpose other than to slow things down. The goal here isn’t information gathering's for information gathering sake. 

The diligence team should know where questions need to be asked. The length of the list - inevitably - depends on the size and nature of the deal, but should comfortably run into a few pages.

Deals at the larger end of the spectrum (those involving big tech firms, for example) can run into twenty or thirty pages full of due diligence requests. The requests should be itemized and easily referred to for future reference. 

The final point to note here is that the list should be reasonably fluid. The list is the means to an end as opposed to an end in itself.

That is not to say that any of the requests on it are optional - if they’re on the list, ignoring them would be neglecting the whole point of due diligence - but rather than scratching the surface on some issues can reveal things that haven’t been considered until that point. 

free checklists & templates

4. Collaborate

Now that your diligence team has been assembled and the due diligence list compiled, due diligence can begin in earnest. Or at least, that’s the thinking.

As many an external auditor has found, often not everyone within a company is willing to collaborate when the time comes to helping with the information gathering process. Thus, identifying the individuals that speed up rather than slow down at this stage is pivotal. 

Typically the team of in-house contacts that collaborates with on due diligence will loosely mirror your diligence team; your legal expert will be assigned to a legal team within the target company, your finance expert will work with a member of their finance team, etc.

Ideally, there should also be an opportunity to meet suppliers and/or customers in their home environment that allows them to provide feedback on the firm with full confidentiality. Carried out well, this process doubles up as an HR exercise.

The interaction with the in-house team will act as a barometer for their enthusiasm for an acquisition. Nobody is saying that it’s the responsibility of a legal or financial expert to jump into the role of HR strategist, but any feedback they obtain can be seen as data points in the wider due diligence process. And avoiding surprises is the aim of the game here. 

collaborate

5. Leverage Technology

There’s only so much information that a diligence team can absorb, and oversights are inevitable in some respects - particularly on larger diligence assignments. But with most records being digitized now in some form, it makes sense to leverage technology to assist with the due diligence process.

Why scan through the minutiae of financial statements when a filter on Microsoft Excel will avoid making potentially costly human oversights? 

The last few years have seen a proliferation of deal making software tools that make a valuable contribution to due diligence.

The DealRoom M&A platform is a case in point, but users should use whichever one works best for them. While these aren’t going to directly ensure that no unpleasant surprises arise in the transaction, they go a long way to facilitating the parts of the process that do.

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In 2012, Caterpillar paid $677 million to acquire Chinese firm ERA, a deal which appeared to open up the Chinese coal markets to the US behemoth. Caterpillar Group President, Steve Wunning said of the deal: 

“The joining of these two iconic companies is an incredible combination.” 

But less than a year later, Caterpillar took a $580 million non-cash goodwill impairment write-down on the acquisition.

How could a player as experienced as Caterpillar get it so wrong? 

Let’s acknowledge for a moment that if it happened to Caterpillar, it could happen to anybody.

The literature on M&A is awash with advice on the importance of preparation in successful transactions but even that doesn’t guarantee that a deal will be a success. 

The broad nature of M&A is that even if you’ve seemingly accounted for every possible outcome, new issues can spring up virtually anywhere after the deal has closed and destroy shareholder value. 

Some problems are difficult to detect even with the most careful preparation. 

In the case of the Caterpillar deal, ERA had engaged in “deliberate, multi-year, coordinated accounting misconduct” Obvious after the fact, maybe. 

You can’t account for everything. 

The long tail of issues that can arise is too long. And even if you could devote more time to going deeper into those issues, you’d probably be destroying value elsewhere by delaying the deal’s closing time. 

The important part is to take steps that minimize the chances of unpleasant surprises arising. 

Here are five crucial steps to take that help prevent M&A transaction risks

  • Follow a framework
  • Build diligence teams
  • Request due diligence materials
  • Collaborate
  • Leverage technology

1. Follow a Framework 

If there isn’t a good answer to the question, ‘why are we going after this deal?’, the chances are that your company hasn’t got a good M&A framework in place. If this is the case, all of the steps which follow below will largely be worthless.

Thus, the first step is to ensure that there is a framework in place which looks at a deal from its conception right through to its implementation and the integration of the target with your own company.

Frankly, this part warrants a book on its own. It encompasses everything from setting a broad acquisition strategy for your firm to follow to how negotiations are conducted.

But the point is, it will be different for every firm, so it’s important that you know what your individual framework is.

It’s hardly controversial to say that having prepared for every step of the M&A journey in detail, you’re less likely to encounter surprises along the way. 

Build Due Diligence Teams

2. Build Diligence Teams

An important second step in the due diligence process is putting together a due diligence team

The team should possess a suitably broad range of knowledge and experience for the deal at hand. While general traits will be common to all teams - expertise in business, legal and financial matters - the best assembled diligence teams are those that are more specific to the deal and the company’s industry. 

The importance of assembling a team with specific knowledge and experience is reflected in the growing popularity of expert networks in due diligence for larger deals. Bringing in an expert may cost more in the short-term, but invariably ends up generating value.

For example, in many cases, a company’s in-house legal time is unlikely to possess adequate knowledge of intellectual property management to provide an informed valuation of the target’s IP. 

The diligence team has an important role to play both before and during the due diligence phase.

Before due diligence has even begun, their role is to generate the due diligence request list (see next item). This is where they can bring their expertise to bear - knowing the right questions to ask. Not only does this minimize the risk of surprises arising, it also gets to the relevant issues faster. 

3. Request Due Diligence Materials

Directly related to putting together effective diligence teams, is compiling the questions to be asked of the target company.

Unless the right due diligence questions are being asked, the right information won’t be forthcoming.

Naturally, this also means omitting pieces of extraneous information that serve little purpose other than to slow things down. The goal here isn’t information gathering's for information gathering sake. 

The diligence team should know where questions need to be asked. The length of the list - inevitably - depends on the size and nature of the deal, but should comfortably run into a few pages.

Deals at the larger end of the spectrum (those involving big tech firms, for example) can run into twenty or thirty pages full of due diligence requests. The requests should be itemized and easily referred to for future reference. 

The final point to note here is that the list should be reasonably fluid. The list is the means to an end as opposed to an end in itself.

That is not to say that any of the requests on it are optional - if they’re on the list, ignoring them would be neglecting the whole point of due diligence - but rather than scratching the surface on some issues can reveal things that haven’t been considered until that point. 

free checklists & templates

4. Collaborate

Now that your diligence team has been assembled and the due diligence list compiled, due diligence can begin in earnest. Or at least, that’s the thinking.

As many an external auditor has found, often not everyone within a company is willing to collaborate when the time comes to helping with the information gathering process. Thus, identifying the individuals that speed up rather than slow down at this stage is pivotal. 

Typically the team of in-house contacts that collaborates with on due diligence will loosely mirror your diligence team; your legal expert will be assigned to a legal team within the target company, your finance expert will work with a member of their finance team, etc.

Ideally, there should also be an opportunity to meet suppliers and/or customers in their home environment that allows them to provide feedback on the firm with full confidentiality. Carried out well, this process doubles up as an HR exercise.

The interaction with the in-house team will act as a barometer for their enthusiasm for an acquisition. Nobody is saying that it’s the responsibility of a legal or financial expert to jump into the role of HR strategist, but any feedback they obtain can be seen as data points in the wider due diligence process. And avoiding surprises is the aim of the game here. 

collaborate

5. Leverage Technology

There’s only so much information that a diligence team can absorb, and oversights are inevitable in some respects - particularly on larger diligence assignments. But with most records being digitized now in some form, it makes sense to leverage technology to assist with the due diligence process.

Why scan through the minutiae of financial statements when a filter on Microsoft Excel will avoid making potentially costly human oversights? 

The last few years have seen a proliferation of deal making software tools that make a valuable contribution to due diligence.

The DealRoom M&A platform is a case in point, but users should use whichever one works best for them. While these aren’t going to directly ensure that no unpleasant surprises arise in the transaction, they go a long way to facilitating the parts of the process that do.

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