Due Diligence in Overtime
A shift to buying intangible assets is adding a month to the process and requiring more experts
Dealmakers can expect to add at least one month onto their due diligence timelines because of investor risk avoidance and the intangible nature of many companies' assets. The extended process now includes industry specialists in addition to the legal and financial expects that are traditionally involved in due diligence, says Michael Nall (pictured), founder of the Alliance of Merger & Acquisition Advisers, a middle market business networking association. The alliance is hosting its Summer Conference from July 9 through July 11 at the Radisson Blu Aqua Hotel in Chicago, with a section devoted to valuing and identifying intangible assets, Nall says.
How much longer is the due diligence process taking?
Many would say that due diligence is requiring at least an additional 30 to 60 days on average, and sometimes longer.
What about the current M&A environment is causing that change?
Boards are responsible for other people's money, so they need to do a very thorough and objective evaluation of every transaction. It's taking longer now because of one really big factor, and that is risk. With yields on Treasuries being at such puny levels, it seems as though many are just not inclined to want to take any high level of risk. Company management is very risk averse. There is another part of it too. There was a point in time where you looked at a business and it was much more tangible - with manufacturing equipment and inventory - and much of the balance sheet was made up of things you could see, feel and touch. But now, more and more of the business's assets being acquired are intangible, with things like brand value and intellectual property rights, and those intangibles are a lot harder to get your arms around. We're still in the wake of this Great Recession, with what some would argue is a very fragile recovery.
Are companies relying on outside advisers more than they used to?
Companies are now looking at specialists in addition to the traditional folks that were doing legal due diligence and the certified public accountants doing financial due diligence. You simply now have an extra level with some of the intangibles and with the marketplace uncertainty. When you look at the track record, most deals have failed to meet the expectations of the buyer. With that sort of historical track record, and people being in a position where they don't want to lose anything, those investing are taking the time to get a third-party opinion. The toughest part of due diligence is organizational due diligence - where you're making a very rigid assessment to see if there is a good alignment between the capabilities and the expectations of the investors and the management team.
Are advisers seeing an increase in business because of a lengthier due diligence process?
Though transaction activity is at a slower pace than we would have thought for this time of year, with so much capital, the advisers are quite busy. Because due diligence is now taking longer, we are seeing an increase in planning ahead. Dealmakers are doing a pre-transaction due diligence review on the part of a savvy seller in advance, to shore up any weaknesses and to accelerate and make a more efficient transaction process. The advisers are busier with the extra effort on behalf of the lenders and investors.
Walk us through the due diligence process. Where does it start?
The first part of due diligence is the financial due diligence, and that's where you are verifying historical information on the balance sheet. Then, there is a review of everything from the corporate minutes to issues regarding human resources and litigation. Then comes the operational due diligence. All three of those sectors are really being looked during the 90- to 120-day period. The soft stuff is the hard stuff - things regarding culture, market perception and other qualitative things are harder to assess.
What should buyers consider during the due diligence process?
One of the things to look at is employee retention. With many prominent technology and service companies, being able to retain key employees is absolutely essential.
Does the increased cost of a longer due diligence process deter smaller companies from making acquisitions?
The idea of making an acquisition to grow is something that is not often thought of by many smaller companies. They would have to be able to identify and align themselves with capable experts, and sometimes it's hard to find those people who are affordable for a smaller company.
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