The importance of non-financial due diligence

Mike Robson, director at advisory firm Azure Partners, argues that those pursuing acquisitive plans must look beyond the traditional financial due diligence that dominates deal-making.

If you’ve decided that merger or acquisition activity is the way ahead for your business, you will immediately be faced with the conundrum that lies at the heart of being successful in what you are trying to achieve.

The conundrum is that while it is relatively easy to conduct current and historical financial due diligence well, the real value lies in future performance. And forward-looking plans are simply not credible without first getting the non-financial due diligence right.

So how do you go about non-financial due diligence, and what are the key things to look out for if you are going to merge or acquire successfully?

We recommend that before you dive down into the different silos of marketing, sales, innovation, and operations, which will be a necessary part of the overall process, you focus on the vision, the strategy and the rationale. This may seem self-evident, but we have seen plenty of businesses make terrible acquisitions because the whole focus was on clever financial engineering, and the companies therefore missed the bigger picture of what and why they were acquiring.

One such company was an established FTSE 100 business involved in a number of leisure sectors. It acquired a £130 million turnover tour operator, which had in turn acquired eight companies operating in five separate sectors within that industry. There were some financial benefits from the positive cash flow the tour operator business model brought and from handling foreign currency transactions centrally. But no significant marketing, sales or operational synergies or benefits were identified.

This led to friction and lack of a coherent focus from the divergent cultures between the tour operators and the acquirer. Most of the businesses were subsequently sold to competitors within the industry – at a significant loss. The combination of a dominant growth culture and a focus on financial engineering, without a good strategic fit and post acquisition management, resulted in significant financial loss and the wasting of management time and effort post acquisition.

A long hard look

The questions you will need to be asking yourself will be around how the target’s current strategy fits with yours, whether you have the same definitions of success as they have, what benefits your respective customers will get from the acquisition, and what prospective new customers will now become available to you.

You will need to fit these different pieces of the jigsaw together to create a vision of what the new combined business will actually look like three years down the line, and to do this successfully you will need to determine properly what the key measures of success for the acquisition or merger really are from the outset.

In our experience a significant cultural clash is the single most likely non-financial issue that will damage merger or acquisition value. For this to be avoided you will have to get to grips with what the core values of each company really are, which can be a challenge for many businesses which have grown under the cover of individual experiences without necessarily having reference to other ways of operating. For many, ‘core values’ can also be a rather amorphous term, lacking in any real precision.

So here are a few things to think about that all combine to create core values. The starting point should be the management of the existing entities and the potential future business. How and where are decisions currently being made in the two companies, and who will lead the combined organization? How do remuneration, recruitment, development and retention practices compare?

Furthermore, what information is communicated to different staff levels in the existing organizations, and do managers and staff really understand the part they are expected to play in achieving the company’s goals? And, ultimately, what is the actual work ethic of the different businesses, and are the joint efforts likely to be successful?

Hunter Ruthven

Bernard Williamson

Hunter was the Editor for from 2012 to 2014, before moving on to Caspian Media Ltd to be Editor of Real Business.