Slow down to go fast: why M&A due diligence matters

The latest EY Capital Confidence Barometer (CCB), a biannual survey of more than 2,900 senior executives across 47 countries, indicates that the global M&A appetite is at a 10-year high.

• Executives’ confidence in an improving economy is at 93%, while it was at 73% a year ago.
• 59% of companies worldwide plan deals in the next year as compared to 52% a year ago.
•  90% of corporate executives expect an increase in hostile and competitive bidding in the next year.
• 88% of corporate executives expect more competition for assets from private equity, and 80% foresee more mega deals (US$10b and above).
• For more than a third of respondents (37%), shareholder activist pressure to reshape portfolios and future-proof their businesses are making executives more eager to acquire.

Many executives indicate that they will pursue M&A to expand product offerings, geographical footprint and customer base. This top line focused growth strategy is a departure from some of the recent traditional deal value drivers: operational efficiencies, production capabilities and talent pool.

Expanding in such a fast-moving, competitive deal environment means that buyers must often conduct thorough due diligence of potential targets in an accelerated time period. In our experience, while private equity buyers routinely look to objective third parties to help them, corporate buyers are often less likely to do so.

This is either because they feel that they have the right level of industry expertise or because of organizational complexity and the number of business leaders involved in the assessment. Either way, we feel that corporations are missing out on a critical “gut check” or safety valve.

 Regardless of whether a 360-degree due diligence is conducted in-house or by a third party, there are a number of critical questions to ask in order to vet potential targets:

• What makes this target strategically attractive compared to the other buy-or-build options?
• What incremental markets, customers or sales channels will be created or accessed by this acquisition? Do we know if the target has already attempted to go after these opportunities? Why or why not?
• What critical assumptions support the business case? What if we are wrong on one of these? Wrong on two of these? Does it change our decision?
• Have the months or quarters leading up to the sales process distorted any of the underlying business trends?
• Do we have a good understanding of the quality of the infrastructure or operations of the company? What is a likely replacement cost or timing?
• What kind of a culture does the target have? Is there any gap between recent performance and the cultural health of the business?

A comprehensive diligence process could be a matter of weeks to a couple of months. While that may seem like an eternity, in this deal environment the wait is almost always worthwhile. Not only are premiums getting higher, but this means that the margin of error is getting smaller.

And remember — just as savvy homeowners will clean up, paint and stage their home before sale, sellers have become increasingly sophisticated at dressing up their businesses before a sale. Proper due diligence will help leaders look past the window dressing, know if a target is truly right for them and define the path to capturing its intended value. It will also help them understand the full range of potential outcomes.

The views reflected in this article are those of the author and do not necessarily reflect the views of the global EY organization or its member firms.