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Capital Ideas for Private Business

Selling Your Business—The Soft Side of Due Diligence

Avoid the Pitfalls that Cause Acquisitions to Fail

By Marc Borrelli, Managing Partner
Atlanta Office, Corporate Finance Associates

business financingMiddle-market M&A has returned, albeit cautiously, and volume is increasing. Strategic acquirers are returning to purchase needed technologies, markets or skills to meet their growth objectives. Private equity groups are still looking for both platform companies and add-on acquisitions.

However, the irrational exuberance has gone.

  • From the acquirer’s side, today’s deals demand solid results and an objective analysis of a target company’s track record, business plan and management team.
  • From the seller’s side, there is often increased demand for the seller to take stock in the acquiring company, accept an earn-out, or roll some of their proceeds into the acquiring company. In these cases, the seller needs to do thorough due diligence on the buyer, especially the soft side of the businesses.

If you are a seller taking equity in the acquirer, accepting an earn-out, a note, or reinvesting some of the proceeds into the acquiring company, your future is tied to the success of the transaction. If the transaction destroys shareholder value you may lose much of your wealth. Therefore due diligence on the acquirer’s business and a thorough understanding of these softer issues is essential to minimize any loss of wealth.

Five Key Aspects of the Soft Side of Due Diligence


A company’s soft side isn’t soft at all. These are the hard-to-quantify aspects of a company that can make or break an acquisition success. Your investment banker will help you identify and ask the buyer the right questions and pursue the answers so you will fully understand the potential risks.

1. Strategic Vision: Do Both Companies Share a Strategic Vision?

A strategic vision is how a company plans to achieve its mission. This strategic vision is central to a company’s identity, market differentiation and productivity.

  • Does the acquiring company have a Vision Statement? (A Mission Statement focuses on the end result; a Vision Statement focuses on how the company will conduct its business).
  • How important is the acquiring company’s Vision Statement? (For example, is it centered on the company’s founding principles or is it the basis of the brand promise?). Does the management live it and do employees embrace it?
  • Can you continue to honor the acquirer’s Vision Statement after the acquisition? If not, how are the changes going to affect the business’ results and the merger’s goals?

2. Operating Strategy: Will Improving Efficiencies Affect Productivity?

Most acquisition valuations and drivers include expected savings from combining operating systems (distribution methods, advertising strategy, product development, customer care, etc.). However, failure to recognize the fundamental differences in the acquiring company’s operating strategy can have serious consequences.

3. Systems Integration: Have You Anticipated the Unexpected?

Most acquisitions require systems to be integrated, but most plans underestimate the possible obstacles that can be time consuming and costly.

  • Specifically what system will be integrated (sales, service, distribution, accounting, HR systems, etc.)?
  • How could the integration disrupt the day-to-day productivity during the integration phase?
  • What is the expected integration period? What if there are unforeseen delays?
  • What is the cost to migrate to the new systems and is this properly budgeted for? What if there are unexpected expenses?

4. Power and Culture: Can You Prevent a Power Struggle?

Understanding the true power structures within the acquirer is key to understand how change will happen, and how effective communication will take place.

  • Who will lead the integration initiative within each company? Are they adequately empowered? How will communication be facilitated within and between the companies?
  • How are the cultures similar and how are they different? What cultural changes will be imposed on your company? What are the possible consequences?
  • What effect could employee turnover have on your company’s performance and value? What steps should you take to minimize turnover?

5. Competitor’s Responses: How Could the Market Position Change?

In many acquisitions, there is little discussion about how the competition may response to the acquisition. This is even compounded in some cases by the lack of attention to the business and customers during the sale process. The fact is, competitors don’t just sit there.

  • Who are your competitors and who are the acquirer’s competitors? What threats do they pose to the businesses? How will they react?
  • What strengths will the target company gain after the acquisition? What strengths will the acquirer gain after the acquisition? How can you take advantage of these strengths?
  • How can the combined company proactively respond to possible competitive activity, and beat the competition to the punch.

Time is Even Softer: It is the Silent Killer

Since most acquisitions are valued on the basis of discounted cash flow, the speed with which the planned synergies are realized is the key to ensuring the transaction generates the expected shareholder value. The longer it takes to realize the identified benefits, the lower the value of it. For example:

  • A company plans on achieving $100K in additional cash flow from an acquisition in the first year.
  • However, the $100K is achieved in the third year, due to slower than expected time to implement strategies.
  • At a 10% discount rate, the value realized is only 75% of the expected value; therefore the company has to realize an additional $33K for the transaction to remain value neutral.

To avoid potential pitfalls that could potentially derail a transaction, plans and strategies dealing with soft side issues need to be in place well before the deal is done so as to minimize their effect on the outcome.

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