Due Diligence: What Is All The Fuss About?

Surprisingly, weak due diligence is rife in the corporate landscape. In a recent survey by Bain & Company, 50% of the 250 international executives surveyed attributed major problems in a deal to flawed due diligence procedures. A staggering 33% admitted they failed to walk away from a deal that they had nagging doubts about.

According to a recent article by Cullinan, Le Roux and Weddigan in the Harvard Business Review, the key to effective due diligence rests with asking four basic questions before committing to a deal.

What are you really buying?
Effective due diligence separates the rhetoric from reality. It constructs a bottom-up view of the target within its industry based on information gathered from customers, suppliers and competitors - not by relying on misguided forecasts about a target’s synergy.

This can be done by testing a deal's strategic logic by reference to what has been described as the “four Cs of competition”: customers, competition, costs and capabilities.

What is the target’s stand-alone value?
To determine a deal’s stand-alone value, it is important to identify all the accounting tricks that distort historical and prospective cash flows. This is often achieved by sending a due diligence team into the field to see what is actually happening with costs and sales.

By taking a disciplined and objective approach to due diligence, unreliable assumptions and flaws in logic may be tested, giving senior mangers an opportunity to back out of a bad deal before it is too late.

Where are the synergies and skeletons?
It is often difficult to determine the synergies that an acquisition will deliver so it is important to differentiate between different synergies, and estimate the cost of achieving them in time and money.

Due diligence should therefore include an analysis of the potential savings from cutting shared operating costs in distribution, sales and overhead expenses, as well as the more obscure revenue synergies such as selling existing products in different markets.

This should be accompanied by an analysis of the potential problems in merging businesses, such as reduced revenue or increased costs.

Conclusion
In the end, effective due diligence is as much about managerial humility as anything else. It’s about testing every assumption and questioning every belief. It’s about not falling into the trap of thinking you will be able to fix any problem after the fact.

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