Mergers and acquisitions involve an enormous effort and spend every year -- upwards of $2 trillion in the United States annually -- but throwing money at the transaction doesn't make it successful. According to the Harvard Business Review, between 70 and 90 percent of all M&A activity fails. HBR points the finger for these failures, at least partially, at poor research and due diligence.
Due diligence isn't just a matter of accounting or legal review; a holistic approach to due diligence creates a much more stable foundation upon which M&A activity can rest. CEOs and CFOs looking at potential M&A activity need to consider at least five primary due diligence types before making any final decisions or moves.
Operations Due Diligence
All of the components of a company's operations -- from tech to insurance coverage -- are reviewed during this type of due diligence. The purpose is to gain an understanding of the state of the company's assets and technology and to identify operational risk that might impact success in the future. Risks might include obvious liabilities, such as an aging technological infrastructure or inappropriate real estate assets to support necessary expansion. They might also include hidden issues, such as minor safety concerns that could become bigger problems in the future.
Business and Process Analysis
This step does the same type of risk analysis with the business processes and related factors, including markets, customers and even the competition. Business due diligence helps the acquiring party understand whether forthcoming industry evolution poses a threat, whether existing processes can be incorporated into new infrastructures and whether the makeup of the company's customer base includes substantial risk. For example, if one or two clients drive a large percent of the revenue, those clients leaving could make the acquisition less valuable.
Conducting Financial Reviews
A 2018 Deloitte report on trends in M&A notes an increase in deals that generate returns when compared to 2016 numbers, but that's far from a guaranteed outcome. A professional review of the target company's books is always critical to due diligence. That includes a CPA review of tax statements, financial reports and financial policies. Financial due diligence is usually a good place to start, because the numbers often inform questions that may be asked in other types of due diligence.
Understanding Human Resources
People are often one of a company's most valuable assets, but they can also bring great risk. Human resources due diligence involves understanding the organizational structure of a company and reviewing the benefits, compensation, management structure and culture that currently exists. Acquiring entities must also discover if there are employee contract disputes, union issues or other matters that could increase labor or HR expenses.
Finally, no due diligence is complete without a legal analysis of all contracts, corporate documents, current or pending litigation, compliance requirements (and issues), and environmental factors. Acquiring a company mired in legal issues -- or a brand that's ignored legal matters -- is typically bad for the bottom line.
Fail points or risks discovered during these five types of due diligence don't necessarily mean a deal is off. It's up to the parties involved to decide if the potential rewards outweigh the risks, but due diligence can put companies in a better negotiating position and help them plan accordingly to deal with any issues once a merger or acquisition takes place.