Although market activity is returning to pre-recession levels there is still an underlying feeling of caution surrounding dealmaking. It has become increasingly important to conduct thorough due diligence prior to completion, but just how drawn-out and painstaking is the process nowadays?
Steven Ivermee, head of transaction support at Ernst & Young, says its clients are now more focused upfront and that if they aren’t comfortable with the buying thesis then they will walk away.
‘Today we are seeing a much more issue-led approach to commissioning due diligence; it’s all more focused,’ he says.
The UK Bribery Act, due to come into force on 1 July, has brought the subject back to the table with the announcement that there will be increased scrutiny of subsidiaries, with buyers forced to increase due diligence on acquisitions or risk liability for corrupt practice.
Harriet Territt of law firm Jones Day argues that the Bribery Act will have a big impact on M&A deals where one or more parties is subject to the Act.
‘Companies need to ensure that they have a full, pre-completion understanding of a potential target’s approach to anti-corruption. Where compliance with the Act cannot be confirmed, deals may even be called off.’
Ivermee sees the new changes as beneficial to the M&A market. He believes that they will force companies to be even clearer with their own procedures, so once they have completed a deal they can ensure that their standard of ethical training and their cultural standards are pushed down to a new entity as soon as possible.
TIME IS OF THE ESSENCE
For fast-growing businesses the speed at which deals can be successfully completed is pivotal. 2011 has already been another busy year of acquisitions for telecoms company Daisy. The implementation of an internal M&A team has enabled deals to be carried out quickly and effectively.
‘After joining Daisy I brought two ex-Ernst & Young colleagues into the business and we created our own in-house due diligence team,’ says Steve Smith, Daisy’s director for M&A.
For Smith, the most difficult aspect of due diligence is when his firm is buying less than 100 per cent of a business. ‘In this case you are really relying on the seller doing lots of preparation work so that they are able to separate the numbers for the part you are buying and the part you aren’t,’ he explains.
Highlighting its own increased due diligence procedures, since taking on bank finance Daisy has been required to supplement its own work with the advice of an independent accounting firm if the acquisition is for more than £5 million.
According to Andy Makeham, CEO of software company K3, due diligence is something that companies should be more involved with themselves.
K3 recently completed the acquisitions of software companies Clarita and Sense, in deals that were both worth over £1 million. It conducted all due diligence in house for both deals.
Makeham explains, ‘We do all our own due diligence; I think people who give due diligence to other people are abdicating responsibility and it’s appalling.’
He argues that successfully getting through the due diligence process is down to being involved at the start so that trust can be built up.
‘By the time we actually do the transaction we usually know more about the business than the vendors – we’ve gone through it with a fine-tooth comb.
‘If we’ve done the due diligence, we know the personalities and we know they are going to fit. By the time we get the business into K3 we don’t want surprises and touch wood we get very few.’
The protracted nature of due diligence was what drew Jamie Apold, a former wealth adviser at J.P. Morgan, to create a new forum for dealmaking.
Apold was frustrated at the difficulty associated with due diligence and dealmaking, and set about providing an alternative to the status quo.
Asset-Ex forms an online marketplace for business assets and combines a place to advertise a sale with an online data room.
The main problem he sees is one of volume: ‘Everyone is so conscious of the implications of not carrying out thorough due diligence that people tend, quite naturally, to overload the bases.’
EXPECT THE UNEXPECTED
However, due diligence is not always high up on dealmakers’ agendas. Jorn Lyseggen, CEO and founder of software as a service (SaaS) business Meltwater, thinks that surprises are all part and parcel of the dealmaking process and that acquisitions are a ‘trust issue’.
He feels that businesses pay for the future prospect, which is inherently full of uncertainty and surprises, and not for the past or present.
‘I’m not a great believer in due diligence. You need to make sure that things are in order, but beyond that we have little interest in spending too much time on the past. Due diligence processes can be really expensive and not always beneficial.’
This approach permeated Meltwater’s recent acquisition of Jitterjam, a customer relationship management (CRM) platform company, for £3.7 million.
Managing expectations and preparing for the worst are important parts of dealmaking, and discovering them at the start of the process is critical, according to Makeham: ‘If we spot something, we are onto it like a rash.
We are a public company so we have very rigid and tight controls about how we are run. Therefore, if we find “funnies” we make sure they are above board or they are handled in some way.’
Ivermee adds, ‘I think we are seeing proportionately a greater number of deals that don’t get to the finishing line because of due diligence issues.’
He believes that the work done early in the process is vital to ensuring that a deal goes through. ‘The first conversation will be about what the key issues that drive deal value are and what the investment criteria are against which we are judging the quality of the assets,’ he says.
Ivermee emphasises that if this is made clear upfront and businesses focus their efforts on addressing the key issues, then surprises will be avoided at the end of the deal.
During the heady heights of M&A activity in 2006 and 2007, due diligence was seen by some businesses as little more than a box-ticking exercise, reveals Edward Hikmet of Armstrong Transaction Services. However, he is quick to point out that there is much more engagement from those sorts of clients nowadays.
The emergence of teams dedicated to M&A highlights the increased awareness that businesses are showing towards finding the most appropriate target and ensuring that the deal is conducted in the most diligent way.
After e-learning courseware provider SkillSoft was taken private in 2010, advisers from the acquiring private equity firm joined the team. The business now employs a team of six people who are focused on M&A.
Kevin Young, vice-president and managing director of SkillSoft EMEA, says, ‘Historically, due diligence has been done with one or two people looking at opportunities. But with the new owners there is a rigour, a process and a structure that is designed to identify any risk.’
SkillSoft recently acquired the assets of 50 Lessons, a provider of leadership video content. The deal is part of the business’s plan to grow through an acquisition strategy that currently has 120 targets under review.
Young emphasises that SkillSoft’s conservative nature means that any acquisition due diligence will be thorough, but he believes that the market is ready for an increase in M&A activity. ‘There are lots of businesses out there that are interested in a trade sale,’ he explains.
The move towards a more dedicated team of due diligence specialists within the company is a way of ensuring that any issues and hurdles are discovered early on in the process, as well as saving money on outsourcing costs.
Makeham speaks candidly about the process when he reveals the issues that have arisen from the enquiry work carried out by K3: ‘We uncover all sorts of funny things: the company that owns a yacht that is moored somewhere in the Mediterranean; the wife who is on the payroll but is never there.’
In a market where businesses are finding it increasingly hard to shift acquisitions that were made in the boom period before the financial crisis, the importance of good due diligence to ascertain the future performance possibilities of a prospective buy is even more important.
However, Jorn Lyseggen is clear that closing a deal is never easy; it’s about both companies being clear about what they want out of the deal: ‘It is more than just a business transaction; it’s like a dating process. I believe that the most successful acquisitions are those where both parties want it, not because of the financial terms but because they want to work as one and are really inspired by the prospects of all the things they can do together.’
As dealmaking evolves, it is clear that due diligence is now more important than ever in determining just how compatible two businesses are.