There supposedly was a time when data rooms were indeed dusty backrooms in which grey haired suits analyzed shelves full of binders, scribbling into their Moleskine notebooks to only after many months make a decision as to whether the chances/ risk assessment justified an investment into a given company.
Thankfully the dusty backrooms are a matter of the past. I am now grey haired myself and got never quite rid of those notebooks. What also persists are month long due diligence (DD) processes, in which investors go through the books of companies to be bought. A process far less entertaining than what Richard Gere sold it to us for in 1990 (but always just as interesting).
The reasons are obvious. The purchase of a legal entity entails the assumption of all respective rights and liabilities and each business model has its peculiarities. Thereby my experience is that less the killer idea but rather process-intelligence and consequent implementation over years pave the way for the success of a company, managing a great deal of details. All of which needs to be understood by third parties new to the particular game.
As to be expected the length of company history also leaves its mark on the DD process. The longer ago the foundation of the company, the more contracts might have been closed in the meanwhile, establishing mutual claims.Size and complexity of the company are just as important. But also the investor.
The company seeking an investment or company sale should always anticipate that tax, financial and legal considerations will be scrutinized closely, hence the common partition of the due diligence into these chapters. Taxes should have been paid or the respective provisions recognized, neither profit & loss statements nor balance sheets present any surprises and the many relations that the company entertains must be well documented in contracts that the investor can rely on in the future. Dependencies are seldom an asset. Never actually.
One of the most interesting segments is the so called commercial due diligence, covering business model, markets and competition. An area that hardly seems to matter when a venture capital player with sector expertise invests in a startup, may rise to an importance that ecxceeds all other due diligence areas when a strategic or private equity investor comes in as buyer.
That is understandable in various ways. The CEO of a strategist is just as responsible towards his board and investors as the financial investor with regards to his limited partners (thus those parties that contribute the lion share to the respective fund). And we already hinted at the, if you like, avalanche of data that need to be given a structure and a narrative.
In this context the commercial due diligence, covering business model, market and competition can be seen as the most crucial, while at the same time the most difficult DD segment to comprehend and assess. The more innovative a business model, the more demanding, at times, a concise and comprehensible presentation. On the receiver end this often requires quite some sense of imagination, which we are always lent to less for topics farther from us. And aforementioned decision makers are not all equally close to digital topics (which we for once use as a synonym for innovation). In comparison VC investors are expected to be more aligned with both hyped and true innovation (then again, let’s be mindful of clichés; the most interesting transactions I participated in carried the mark of brilliant strategic investors that understood their own operations as much as the novel business models they were about to incorporate).
At which point innovation may fire straight back. Not to mention the issue of synergies, thus the hopefully positive interrelation (again, to be shown and proven) between existing business areas of a buyer or investor and the organisation to be taken over. Adding yet another level of complexity.
From experience a transaction that otherwise seems entirely manageable process-wise may turn into a rather complicated affair from this intersection in the DD onwards. And the more interesting the target to the buyer as a carrier of innovation, the more this might be the case. Instead of sitting down and talking things through – which however requires the honesty to admit that not everything is quite clear to each and every member of the board of directors – more and more data are collected. Trying to escape from this analysis paralisis, additional, likely redundant question catalogues are drafted. Which can than be indeed somewhat taxing for the managers of the target company.
Sounds harmless. But a due diligence really is one of those processes where surprises and frustrations need to be avoided. Given that even smooth company transactions imply administrative and workload requirements that exceed by far what entrepreneurs were used to up to that point.
Since transactions are always the acomplishement of several parties that do not relate to each other hierarchically, the respective communication requires quite a bit of tactfulness and standard solution are hard to get by. Let’s take a shot though:
- In preparation ensure maximum transparency in all due diligence areas. The expression „to dress up the bride“ relates to something different in an M&A context. I would rather speak about „cleaning up the attic“. In preparation for a company sale it is really particularly important to document really every single operational transaction.
- Be proactive, understand where your partner comes from and anticipate questions, early on. A due diligence process does not serve the purpose of explaining basic business processes. The goal is much more to x-ray the target company to detect potential problems that are not that apparent. Sometimes not even for the current owners themselves. It is therefor in the best interest of the sellers to deal with more profane topics as part of the management presentations. That will not take more than a few hours. Move these issues to the due diligence process and what could have been a coffee break topic might keep you busy for dozens, if not hundreds of hours.
- Watch strict logic. Often KPIs relate to each other rationally and can be deducted one from another. The first Euro gained in revenues is often the product of a times b times c. And this is where both pitches and the due diligence presentations you will be asked for differ wildly (on a side note: the 10 slide pitch that landed a 100 Mio. Euro investment does not exist – that is marketing, whatever the goal). Of course one wants to remain brief and concise, but delivering complex information always requires a fair amount of slides (and excel sheets).
- Do not get caught up in the buzz. The clear documentation of the business model, independent from any supposedly disruptive innovation, makes the job of the commercial diligence advisers a whole lot easier too. That way there is no need to think about „translations“ more appropriate for decision makers that were not involved in the early stages of the transaction process, or, as mentioned, professionally less involved with the niche you operate in up to that point. It is hence advisable to use sector specific buzzwords with care. Crypted language needs to be uncrpyted. How well depends on the time and the experience available. Neither can be taken for granted.
- Co-manage the process. Do not fall victim to the due diligence advisers. Their question catalogues serve the goal of documenting your company. Question catalogues that are not that meaningful, should be discussed and adapted. In both your as the target company and the buyers best interest.