Keiretsu Forum
3466 Mt. Diablo Blvd.
Suite C-205
Lafayette, CA 94549
© 2004 Keiretsu Forum.
All rights reserved. |
| If you like this newsletter, please forward it to your friends for them to subscribe. |
|
|
|
An Introduction to Operations Due Diligence
By Michael Sarlitto and Dan Roman, Chicago Members
M&A Failure
Organizations such as A.T. Kearney, PricewaterhouseCoopers, McKinsey, and Business Week have produced conclusive research – there is a startling high failure rate for newly-acquired or merged businesses. Within 18 months of closing, 80% of large cap, 50% of small cap, and 80% of micro cap transactions fail to meet stakeholder objectives (see Exhibit #1).
Separately, Mergerstat.com spent two years tracking results from the 8,224 domestic transactions conducted in 2001. The study estimates that a staggering $560 billion of business value was destroyed due to M&A failure. What was their conclusion? “Companies continually embark upon the merger and acquisition trail without fully understanding the risks ahead.”
Many reasons are cited for M&A failure (see Exhibit #2), including culture clashes, integration challenges, and changing market conditions. But, are these reasons merely a collection of industry accepted excuses masking the root cause of failure?
SummitPoint Management conducted detailed root cause analysis1 on more than 200 cases of failed merger and acquisition transactions. The results were intriguing – we found that a large percentage of merger and acquisition failures are preventable. In fact, very few failures occur because of weak financial valuations, flawed legal opinions, or poor auditing skills. Rather, poor outcomes most often result from a failure to discover and address operational risks inherent in business and work processes, particularly during the due diligence phase of a deal.
Savvy investors are beginning to recognize the value of incorporating operations due diligence along with financial and legal due diligence as part of the deal process. An in-depth examination of operational factors can increase the likelihood of long-term deal success.
What is Operations Due Diligence?
Operations due diligence is the methodical process of investigating and evaluating the operational details related to a potential investment or business initiative. Its purpose is to:
- Discover operational issues and risks material to the transaction,
- Verify initial financial, legal, and operational assumptions,
- Allow parties to address these issues and risks prior to closing,
- Narrow the focus of representations and warranties,
- Identify opportunities for post-close value creation, and
- Prepare for merger integration.
The value derived from the identification and mitigation of operational risks is not just limited to mergers and acquisitions, but also applies to debt or equity placements, joint ventures, institutional lending, and performance improvement initiatives.
It is important to understand that “operations” in this context must include all business and work processes throughout every functional area of the organization, such as finance, human resources, information technology, supply chain, property management, sales and marketing, strategy, and operations. Limiting the assessment to only those few functions of a company that supports its main activity may omit important factors that could impact a deals success.
We recommend that those performing operations due diligence follow a three-step integrated process. First, gather critical operational-based intelligence using an integrated and repeatable process. Second, assess business activities, processes, and operations in a comprehensive manner. And third, align the due diligence activity and availability of intelligence with the decision-making timeline and the goals of the acquisition and/or merger. This integrated approach toward gathering, assessing, and aligning a firm’s processes, operations, and activities will reveal key interrelationships, disconnects, and higher order synergies between operations-based functions.
By modifying generally accepted due diligence practices to include a penetrating assessment of operational-based factors, stakeholders are able to make more informed investment decisions, add post close value, and are subjected to fewer surprises.
Conclusion
On average, 80 percent of newly-merged businesses fail within 18 months of closing. The majority of these failures do not take place because of poor financial valuations or auditing skills. In fact, the poor statistical performance is caused by a failure to discover, assess, and account for operational risks inherent in business and work processes.
This strongly suggests that operational risks should be included in future due diligence audits for proposed mergers and acquisitions of all sizes. In order to reveal key interrelationships, disconnects, and higher order synergies between operations-based functions, it is crucial to gather critical operational-based intelligence. An integrated and repeatable operations due diligence process can meet this charge.
Using an operations-based assessment process to discover, assess, and account for operational risks, coupled with typical due diligence, can greatly increase the probability for merger and acquisition success.
About the Authors
Michael Sarlitto is President and Dan Roman Vice President and General Manager of SummitPoint Management. SummitPoint Management is a Chicago-based consultancy offering operations due diligence and advisory services to firms seeking to acquire, invest in, or enhance the performance of companies. They can be reached at 312.441.1400 or www.summitpointmanagement.com.
Exhibit #1: Failure Rates by Transaction Size
Exhibit #2: Top Ten Excuses Offered for M&A Failure
| 1. Culture clash |
| 2. Overpayment |
| 3. Poor business fit |
| 4. Integration failure |
| 5. Over-leverage |
| 6. Boardroom schisms |
| 7. Regulatory delay |
| 8. Market conditions |
| 9. Poor business judgment |
| 10. World events |
1 Root cause analysis is an efficient, systemic, objective and comprehensive investigative technique for problem cause identification
| | |
