We all understand that T s should be crossed, I s must be dotted and rows & columns of numbers should reconcile exactly. But an obsession with absolute accuracy and complete perfection can destroy the ROI of an acquisition or roll up. A board member (Director) can help by asking questions about the optimum pacing for transactions and the key factors driving the success of acquisitions.
Situation # 1: Investors based in Europe were expanding their company to become a multi-service one stop shop. Since their first two acquisitions were specialized companies, it was time to strengthen their account and project management capabilities. Their due diligence process for the third acquisition dragged on for over a year. The target company’s 45% growth rate slowed to 25%. Valuation was adjusted three times. Some key employees who could have become key contributors to the success of the combined businesses lost confidence in the acquiring company and accepted positions elsewhere. The distraction of the onerous due diligence process definitely increased the cost of acquisition, cost them opportunities and slowed integration. Once the transaction was completed, everyone involved concluded that they should have just used their initial valuation “guesstimates.” They lost MILLIONS as the accounting departments parsed numbers that impacted hundreds. They would have made more money if their guesstimates had been off by as much as 30%!
It pays to gauge the PACE of the industry involved before committing to a specific due diligence process. It pays to know how quickly a transaction must be completed to achieve the desired competitive advantage before establishing the due diligence budget and timeline.
Situation # 2: Another investor had a similar vision. He would acquire complementary companies to provide a range of services for corporate accounts. They ran into difficulties when the next target company was being courted by multiple investors with varying approaches to due diligence, valuation and integration. Even though the prospective buyers were from Asia, Europe and South America, one might still assume that generally accepted accounting practices (GAAP) would yield comparable valuations. In this situation the variations in what constituted gross profit ranged from 32% – 38%; which is a huge difference. When it comes to B2B service businesses, stable scalable gross profit is central to success. This transaction got bogged down because each prospective buyer expected the target company to invest in additional accounting to match the prospective buyer’s definitions. The target company would need to have the equivalent of 4 sets of books to continue negotiating with the three prospective buyers. A fourth buyer, who could deal with accounting differences later, bought the target company while the other three were still focused on the definition of gross profit.
It often pays to accept different (even less sophisticated) financial reports from companies that are targeted for acquisition. Your estimate of the cost of upgrading the accounting later can be considered when the purchase price is established.
Situation #3: Same scenario – a roll up to become a one stop shop on a global scale.
The buyer’s due diligence process was very precise re. inventory, backlog, accounts receivable, repeat business, average order size, etc. But very little attention was focused on the people. Long story short: a handful of people in each of the acquired companies had large compensation packages, impressive C level job titles, and expectations that they would retain authority over their piece of the blended company. They also had varying levels of experience, skills and sophistication. The cost, risk and complexity of leadership integration and/or replacement absolutely dwarfed the precise numbers that were generated about “things”.
It pays to remember the Pareto Principal (80/20 rule). The best transactions follow due diligence that has emphasized the key factors behind success or failure. Acquisitions often involve “companies in search of a CEO”, so leadership-related due diligence matters.