By Laura Kevghas and Donald Richards

Top Five Buyer Blunders and How to Avoid Them

Many of the past Viewpoints we’ve published have advised sellers on how to secure a great deal in the M&A market. In this issue, we take a seat on the other side of the conferencetable to highlight five common and sometimes critical buyer mistakes that can be fatal to a transaction.

Some of these mistakes or misunderstandings can cause a seller to mistrust a prospective buyer. Others lead a buyer to present an offer that doesn’t meet the seller’s needs or interests.  In any case, they can result in a deal that’s in serious jeopardy.

Why This Matters:

Most buyer mistakes are avoidable. Being aware of how things can go wrong will help you improve your chances of sealing the deal.

1. KNOW the Real Decision-Maker(s)

Things can get off track right from the start if you don’t take the time up front to clarify key and hidden Decision-Makers in the seller’s world. John Kenny, Executive Vice President of Corporate Development for Iron Mountain, states that one of the most important factors that needs to be uncovered early on is whether the people that you’re dealing with on the seller side are the people who can actually approve a transaction. “I’ve seen a lot of cycles wasted and deals just never get done,” he said, “because you’re talking to someone who isn’t authorized to make a decision, or the board isn’t aligned with the sale.”

Although unfortunate, it is not unheard of for someone on the seller side to overstate how much authority they have to get a deal done. Mirus once had a principal of a seller represent himself as the sole decision-maker, only to have the partner committee turn down the letter of intent the principal had negotiated because his partners did not want to sell the company at any price!

Exaggeration of authority may be difficult to ascertain, and supports the idea of asking probing questions up front . Confirming as many deal-related details as possible early in the relationship helps streamline the deal process and keep it from derailing.

2. DON’T Focus on Price Alone

Some buyers assume getting the best price possible is the only thing that matters to a seller. In reality, many sellers have other goals that are important to them. Not taking time to uncover these objectives can be a big mistake.  John Kenny also advises learning as much as possible about the complete dynamics of a seller’s situation in advance. “One of the first questions to ask is why the asset is for sale,” he adds,“…and also understand whether it’s a distress situation and whether it’s been shopped for a while. Are they shooting for the whole market, or targeting you specifically?”

Mirus represented a client recently who wanted to ensure that his staff, many of whom had helped him grow the business for more than twenty years, had bright futures with the company post-acquisition. One finalist in the auction process,who didn’t believe this was a real objective of the seller, was dropped from the process despite a high proposed purchase price, when they indicated that they planned to cut employees and close facilities after the close of the sale.

Similarly, many entrepreneurs want to know that the company brand and culture they’ve spent years building–and which they believe support their company’s success–are going tobe maintained. Factors like these are often especially important when a family owned business goes on the market.

“Seller motivations are important, because if the seller cares about their brand, or their people, or their staff’s ongoing employment; and these factors don’t match up with integration into the new company, then you might as well stop–because you won’t be the preferred buyer,” adds Kenny.

3. Romance the Seller

Sellers want to believe a prospective buyer is really pursuing them and truly cares about the business the seller has built.  This is especially true if the seller is planning to stay involved with the business, but it can also be true even if the seller is planning to exit.

“You need to distinguish the different situations,” said attorney Les Fagen, a partner in the Venture Capital practice group at Cooley Godward Kronish’s Boston office. “If it’s a family-owned or founder-owned business, not spending time ‘romancing’ the seller can definitely be a problem.”

Taking time to get to know the seller, and letting the seller get to know you, are essential to building the type of personal bond that will help move a deal forward. Making sure that there are enough face-to-face meetings, spending time getting to know sellers and their key players, listening closely and asking good questions, and helping the seller learn about you are examples of the types of things a buyer can do to help a seller feel “wooed” and special.  At the end of the day, relationships buy companies.

4. BUILDING A Win-Win DEAL

Some buyers focus on winning during every negotiation with the seller, whether it’s related to the purchase and sale agreement, employment agreements or post-closing integration. Every purchase and sale agreement has numerous points that involve a give and take between buyers and sellers. Sellers can get fed up and walk away, simply due to the perception that a buyer is trying to shift all possible risks to the seller’s side.

“Being too aggressive in negotiating the indemnities in the purchase agreement is one of the more common problems,” Les Fagen elaborate(s) . “The seller wants certain limitations on liability, and the buyer wants all these protections in the document. Not wanting to intelligently assume risk on a buyer’s part is probably one of the most common reasons that deals fall apart.”

5. Organization

A seller can quickly lose confidence when a buyer doesn’t appear competent or knowledgeable in terms of how they approach the sales process. “One of the key success factors for an acquisition is earning the seller’s trust, that you will indeed be able to close the transaction,” pointed out Fagen. “The seller wants to know that the buyer has the ability, the wherewithal, and the determination to close and close promptly. I’ve seen a number of deals fall apart because the buyer took too long and didn’t keep the process moving forward.”

The due diligence process is seen by many sellers as a proxy for how they will work with the buyer post-closing.  A smooth due diligence process comforts the seller and his/her management team that the buyer’s company is also well run, and that integration and post-closing activities will be smooth and well-managed.

Planning for Success

Buying and selling a business can be challenging for those on both sides of the table. If you’re on the buyer’s side, understanding as much as you can about your seller in advance will help you anticipate and avoid the common mistakes discussed here. Through good planning, excellent listening and communication skills, understanding your seller’s motivations, and knowing your seller’s key influencers; you can become a successful buyer, and complete profitable transactions.

Laura Kevghas is a principal and Donald Richards is a partner at Mirus Capital Advisors, Inc., with a collective history of more than 150 buy-side transactions. Mirus is a middle-market investment bank that specializes in advising companies on strategic mergers and acquisitions. By combining a proven process, industry and  transactional expertise, creative thought, and personalized service, Mirus has completed hundreds of transactions for both public and private companies. Mirus is a registered broker-dealer and FINRA/SIPC Member. For more information, visit www.merger.com.

Investment Banking Services Since 1987 - 200 Wheeler Road, 4th Floor, Burlington MA 01803 • Tel: 781-418-5900 • Fax: 781-418-5999 • www.merger.com

By William S. Andronico and Craig Eaton

As the U.S. emerges from the recession that has plagued the economy during the past 18 months, private equity firms that have been entrenched in their investments are beginning to evaluate exit options in the hopes of earning what is now a long overdue return on their investments. However, there is still a lot of uncertainty on the horizon and as a result, transactions are being subjected to deeper scrutiny as buyers seek out companies with a compelling growth story that can withstand today’s prolonged due diligence process.

In this market, there is no guarantee that any exit will be as timely or profitable as fund investors would hope or require, but market ready businesses can still be sold quickly and at a solid multiple. The key to success? Strategically preparing for an exit. Not only will exit readiness enable the efficient execution of a sale, but it will also maximize its value.

How Important Is Exit Readiness?

As credit markets have tightened, it has become even more critical that companies looking to sell anticipate risks and issues that might arise and potentially disrupt, or lower the value of a deal. Buyers will undoubtedly uncover any hidden problems during the buy-side due diligence process; therefore, it’s important that the seller is aware of any “hidden gems” and has that knowledge available when negotiating sale price.

In addition, there is an ever-present “need for speed” during any transaction, particularly given the drain on management’s time and energy associated with preparing for and executing a sale. In order to quickly and effectively execute a transaction, it’s critical that the seller is fully prepared to exit when the business is taken to market. If not, the seller risks exposing the company to the buyer, prolonging the deal and ultimately lowering the sale price.

Sell-side Due Diligence: Readying For An Exit

Sell-side due diligence is a valuable component of any exit strategy, particularly in today’s uncertain economic environment. Sophisticated bidders have advisors on hand to find any problems within the business and therefore, it’s important that the seller has taken an in-depth look at the company in advance to prevent any unwanted surprises. Sell-side due diligence allows the seller to proactively address any risk areas of the deal and can even expedite the transaction process. Well executed sell-side due diligence includes a thorough assessment of the financial health of the company, as well as an evaluation of all operational, technological and human resource issues. A thorough sell-side due diligence partner assists with five critical phases of the deal:

1. Pre-sale planning. The seller and its due diligence partner must identify any potential issues in order to avoid broken deals or decreased valuations. Pre-sale planning includes performing due diligence and preparing an analysis of the business positioning, providing support and insight for the information memorandum and assessing the baseline valuations range, among other activities.
2. Data room and management presentations. It’s critical to develop financial data and schedules on a basis of accounting consistent with the information memorandum.
3. Negotiation and execution. Sell-side due diligence enables the seller to anticipate the purchaser’s challenges to valuation, support negotiations from a fact-based position of strength and avoid any delays to the transaction process.
4. Operational separation. The seller and its due diligence partner must proactively identify any stand-alone issues including commercial and customer risks, and analyze the cost of those issues.
5. Post-closing issues. Once the deal is closed, the information garnered via thorough sell-side due diligence can help with purchase price adjustments and other post-closing issues that might arise.

Sell-side due diligence allows sellers to counter transactional risks by taking a proactive approach to mitigate potential deal breaking issues. Before moving forward with a potential deal, sellers should:

• Evaluate the financial health of the company by assessing the quality of earnings and identifying any non-recurring charges or credits to maximize the company’s value;
• Develop realistic budgets and forecasts;
• Assess trends in revenues and EBITDA to identify key business drivers;
• Appraise the quality of assets to be sold and liabilities that would be assumed;
• Evaluate trends in required working capital and develop a target working capital level in advance of the purchase agreement;
• Appraise the impacts of fixed versus variable costs, capital expenditure requirements and the importance of certain administrative activities;
• Identify internal management and operational weaknesses, as well as any potential transitional issues;
• Identify tax risks including federal, state and sales tax obligations;
• Determine the optimal tax structure of the seller before the deal and for the deal, and evaluate the impact on potential buyers;
• Consider related party activities and the related transfer pricing or intercompany activities;
• Define key terms and expectations in purchase agreements;
• Mind the GAAP (Generally Accepted Accounting Principles)

Tax Pitfalls and Opportunities

Whether the exit involves an IPO, a strategic/financial acquisition, or another exit option, tax matters can and do drive valuation, specifically when valuable tax assets such as net operating losses and tax credits exist. Two primary areas that require attention are the deal structure and the optimization of the underlying tax assets residing within the target.

From the seller’s perspective, it is essential to:

• Negotiate whether the sale will be an asset sale or a sale of stock. From a tax standpoint, a stock sale will generally benefit the seller and therefore, if it is an asset sale, it’s important to get a premium on the asset sale to put the seller in the same after-tax cash position.
• Consider state tax exposures prior to sale and to mitigate any concerns that might arise. For example, the seller should look at how to structure the sale from a state income tax perspective, evaluating ways to allocate income to low-tax states.
• Look at items such as tax accounting methods that might trigger income on an asset or stock sale, and evaluate how to mitigate the impact on the sale.
• Look for the possibility of tax-free reorganizations, particularly if dealing with a public strategic buyer.

An agreement between the parties related to taxes on a pre- and post- transaction basis should be drafted. Issues related to taxes such as documentation related to basis, net operating losses and credits come up several years after transactions are completed and it is important to identify the responsibilities of both the seller and buyer. This includes taxes triggered through change-of-control payments.

The choice of entity and whether the sale is structured as the sale of stock, a straight asset sale or a deemed asset sale can have many variables that should be considered prior to sale.

Looking Ahead…

As markets and exit multiples continue to stabilize and investor demand for liquidity continues, private equity firms are seizing the opportunity for potential exit strategies – looking to maximize the return on their investments. However, planning how to exit an investment is just as important as completing the transaction. Companies should be sure they’ve considered all options and invest proactively in presale diligence to expedite the sale process, maintain control and credibility, and enhance exit value.

By William S. Andronico

By Michael Oleksak

Over the next several decades, millions of U.S. businesses will be sold, merged, recapitalized, gifted, closed, or liquidated. In any of these events, both the owner and the company’s value will benefit from advance exit planning. Financial executives, whether internal or external, play a key role in educating company owners on the basics of exit planning.

If you are the lead financial officer of a privately-held business, such as CFO or VP Finance, part of your fiduciary duty is to protect the company from the risk of an unplanned change of ownership, through sudden death, of both the shares and the operation of the business.  You also play an important role in increasing the company’s value by strengthening it for the possibility of a future transition or transaction.

Whether you are an internal or external financial advisor, you should make the business owner aware of three things every owner must have: a will, a succession plan, and an exit strategy.

The will protects the ownership of the firm in case a tragedy or sudden death affects the owner.  With a will, the shares will stay out of probate court and land in the hands of the person or people chosen by the owner, thereby ensuring some sense of business continuity.

The succession plan will help with the orderly transition of the operation of the business if the owner is suddenly incapacitated.  The exercise of preparing a succession plan will also help establish whether internal management is strong enough to handle running the company without the owner.

The exit strategy will be the catalyst to determine whether the company is ready for some other entity to assume ownership. Are the books and records, processes and systems, management and employees, business model, brand, public image and reputation desirable enough for someone else to pay to acquire it? If the answer is yes, the next question is would the acquirer be external or internal?

Exit Options

The owner’s external exit options are sale to a strategic buyer or sale to a financial buyer or private equity group. Internal transfer options include a management buy-out, a sale of shares through the Employee Stock Option Plan (ESOP), or gifting of shares, usually to the next generation of the owner’s family. Each of these five exit options has a different valuation range, with external transfers generally having higher values. The owner will also relinquish control of the firm after the external transaction, giving up the ability to subsidize his or her lifestyle through internal expenses. The external exit option also eliminates the owner’s control over his or her legacy, so the owner must determine his or her financial and emotional readiness to exit the business.

If the owner is emotionally ready to leave the business, but needs the highest financial return, as the financial advisor you can recommend that a sale to a third party strategic or third-party financial buyer should be considered. Under these arrangements, it’s important to calculate investment banking and legal fees, as well as taxes, because all will be subtracted from the amount of the check the owner will cash at the end of the day. Due diligence by the third party buyer will be thorough. If there are family members working in the business, their employment may be at risk if the current owner is not calling the shots.  The owner may be required to bridge any financing or value gap with seller notes or earn-outs over time.

A management buyout (MBO) creates a different risk to analyze: is the management team capable of continuing to generate enough cash to pay out the owner over time? Some industries lend themselves to MBO’s better than others, such as construction. Such a deal will require outside financing from a bank or another source, and management may be required to pledge personal assets to support a bank loan. Seller notes will also likely be part of the financing. After the buyout, the owner may still be involved and may retain some financial expense benefits under the deal. The further in advance this option is considered, the better the owner can prepare the team for the execution.

An ESOP is a tax-advantaged, though administratively complex, way for the owner to take some money off the table by selling shares to employees and management. Under a buyout or transfer through an ESOP, the owner will likely remain in control if less than 50% is sold, and will continue to have some personal expenses paid by the company.

Gifting is also a tax-advantaged way to transfer ownership, usually to (hopefully capable) family members. The owner can stay in control and have expenses paid for by the firm. This option will cause complications in relationships, especially as you get deeper into the second and third generations of the family.  Capable outside consultants with experience in family business issues should be considered to help smooth out issues.

All the options that financial executives can suggest for exit strategies carry different valuation ranges, with external transfers having higher valuation ranges (and higher tax impacts). However, a clear awareness of each will help the owner and the company mitigate risk and prepare for the future.

Published in Financial Executive

Michael Oleksak was a commercial lender for 17 years at Bank of Boston. He is a principal at Trek Consulting LLC, Woburn, Massachusetts and co-founder of the Exit Planning Exchange. He works with small and medium-sized businesses to improve performance and value and to prepare for exit.

Contact him at oleksak@ trekconsulting.com - www.trekconsulting.com

© Copyright 2010 Michael Oleksak. All rights reserved.

By Joseph J. Rahal

Introduction

Many of today’s world conflicts emanate from a clash of cultures. The same can be said of conflicts that occurred during the mergers of the Mercedes and Chrysler, Coke and Snapple and many other similar transactions.

Are these cultural issues any different when merging two established and successful smaller or mid-sized companies?

Are the challenges and obstacles the same?

How much of the success of any of these examples is based solely on the formal review, analysis and integration of financial and legal matters?

What must be done to insure a successful blending of companies? Large and Small.

Consider the following ……

• 60% – 70% of all mergers fail because of a lack of cultural integration
• Culture is ranked higher than salary as a criterion in job selection, satisfaction and employee retention
• Customer service is a direct reflection of a company’s culture – how it treats its employees and the expectations it has on how clients should be treated

This document will provide:

• Further rationale and value to conducting a cultural due diligence as a necessary complement to the standard financial and legal due diligence  
• Components of cultural due diligence
• A practical outline for conducting cultural due diligence
• Role of Rahal Consulting in conducting, and implementing strategies resulting from cultural due diligence

This document also presents Rahal Consulting’s philosophy and approach toward defining Cultural Due Diligence and heightening its awareness and relevance in today’s business world. Additionally, Rahal Consulting seeks to challenge conventional thinking, educate business leaders, and to re-affirm the critical value of conducting Cultural Due Diligence along with tradition financial and legal due diligence.

Description

In describing cultural due diligence, there are many positive examples in business, and they stand out among the many negative situations. The over-riding theme in evaluating true corporate culture is “walking the talk”. Here are two specific comparative examples whereby the company may espouse a cultural value but either “walks the talk” or is inconsistent in what is actually done:

If so much that has been written and discussed specific to culture and its importance, why then is culture so often overlooked when two companies merge, especially during the due diligence process?

There are two primary reasons:

1. It’s all about the numbers and value to the shareholders, public or private
2. The perception of cultural due diligence is that of “soft stuff” with limited impact on shareholder value

Clearly, research in all forms, has proven the critical value of human capital to the success of businesses.

Outcomes of Cultural Due Diligence

Conducting cultural due diligence, along with the legal and financial components of traditional due diligence, will:

• Provide better understanding of who you are
• Streamline the integration
• Expedite operational success
• Improve marketplace acceptance
• Retain key employees, clients and revenue

To make the merger successful, there are three distinct steps to cultural due diligence:

1. Conducting an objective, formal and thorough analysis, evaluation and comparison of the two companies
2. Accepting the findings as a pathway to a smoother transition
3. Creating and executing the right strategies for a speedy and successful merger and integration

Important Merger / Acquisition Considerations

Within these steps are critical questions pertaining to successfully merging cultures that must be asked.

What assets are you buying when you join two companies, regardless of size or industry?

• How do you establish and value these assets?
• How will you measure the success of the merger and integration?
• When will you measure the success of the integrated companies?
• What are the contributing factors to the success or failure of the merger?
• What are the inhibiting factors to the success or failure of the merger?
• What role does human capital play in the merger and subsequent success or failure of the merger?
• What are the consequences of incompatibility?

Traditional Due Diligence

Due Diligence has been defined as ‘the independent investigation of a company, its management team and its prospects for success by an investor before funding is provided’. A more terse but no less accurate definition describes it as ‘a well-established mating ritual … which allows [the parties] to explore the benefits of the marriage’. (a)

Conducted primarily by lawyers and accountants, it focuses on:

• Financial structure and performance
• Product portfolio
• Customer base
• Marketing, sales and distribution structure
• Research and development
• Management and personnel
• Legal matters

Traditional Due Diligence occurs between the signing of letters of intent and the closure of the deal, covering typically a ninety-day period during which the parties are still negotiating even as the lawyers and auditors are gathering their information. It can be a draining process. As Charles Crosthwaite, Partner at Bird & Bird, observes, “Due Diligence reports are usually compiled and delivered to extremely tight deadlines. Lawyers cannot, however, guarantee that their reports will be read or acted upon. Professionals should strive to collaborate with clients to create a more effective intelligence gathering and assessment process.”

Many of the components of Due Diligence – the warranties and disclosures which have to be supplied by the legal entity being acquired – are statutory and formula driven. Focus throughout is on evaluating the evidence which will allow the transaction to be concluded. The link between orchestrating the deal and realizing the potential of the new organization is not the responsibility of lawyers and accountants, who may well have no further role to play after the agreement has been signed.

A New Component

Despite the assumption that there is only one component to the due diligence process, there are actually two primary components of Due Diligence –

1. The more recognized and traditional “Confirmatory” process outlined above
2. The less considered “Operational or Business” due diligence process to understand the practical issues that are the day-to-day  heart beat – strategies, structure, practices, people, i.e. the Cultural Due Diligence

Defining Cultural Due Diligence

Cultural Due Diligence, with its focus on the future life of the company, integration of the entities and practical operations of the new organization, has much to offer. As Richard Lee, Partner at Clarks Solicitors, observes, ‘Many companies are extremely unsophisticated in their approach to the cultural aspects of their Due Diligence. Family businesses, in particular, can be hard to integrate”.

Cultural Due Diligence differs from standard Due Diligence procedures in that:

• It is not mandatory in law
• It may be variously conceived and implemented
• It may be conducted by a range of parties

 A Cultural Comparison

A parallel can be drawn between the merger of cultures between nations and the merger of cultures between corporations and businesses of all sizes. Elements in this comparison are numerous but often not considered in the business world. Examples of these elements are:

As analogous as this comparison is, the culture of a business is more difficult to distinctly express, yet everyone knows the importance of culture in the success of a business For example, the culture of a large, for-profit corporation is quite different than that of a hospital that is quite different than that of a university or a strong entrepreneurial business.

You can often identify the culture of an organization by looking at the arrangement of furniture, what the employees and management brag about, what people wear, etc. — similar to what you can use to determine an individual’s personality.

The concept of culture is particularly important when attempting to manage organizational change. Practitioners are coming to realize that, despite the best-laid plans, organizational change must include not only changing structures and processes, but also changing the corporate culture as well.

It is essential to consider that when creating change, the critical components are not setting forth what the goals are but rather the “HOW’ to achieve the desired outcome. The “HOW” is all about implementation and execution. It requires understanding obstacles, outcomes, ramifications, planning and the impact of change on the people who must execute the strategies and tactics.

(a) – Source: Written by Carter McNamara, MBA, PhD, Authenticity Consulting, LLC. Copyright 1997-2007.Adapted from the Field Guide to o Leadership and Supervision.

Done simultaneously with traditional confirmatory due diligence, Cultural Due Diligence is a practical, step-by-step approach for making rapid, cost-effective cultural assessments of both the acquirer and the target. It can make the difference between deal success and disappointment.

Culture and Change

Because cultural change involves hard and soft issues, it requires both qualitative and quantitative analysis of a corporate culture, including visible manifestations such as:

• Dialogue between levels
• Decision making process
• Accessibility to decision makers and leaders
• Sales process and positioning
• Channel management, and “go-to-market” strategies and tactics
• Market positioning
• Client interaction
• Dress codes
• Office layout
• Annual reports
• Recruitment brochures and employee interaction
• Less tangible corporate values and assumptions about how a company does business

Traditional Mergers and Acquisition (M&A) due diligence has consisted mostly of crunching numbers, securing intellectual property, examining executive compensation plans, reviewing legal document, etc. There are several reasons for this:

• Tradition has established a mystic around the “confidentiality” surrounding the legal and financial undertakings
• It is a more specific and easier route to gather and analyze numbers
• Acquisition teams are comprised mostly of financial analysts and attorneys
• Top managers are generally more comfortable with “hard,” easily quantifiable issues than softer ones like culture
• The due diligence team is rewarded and recognized for the accomplishment of the process and seldom, if at all, involved with or tied to the successful integration and future outcome of their assessment
• Less emphasis has been placed on the actual integration and implementation of the merger
• These same managers may have believed they already understand the cultural differences between their companies and prospective partners, particularly if they operated in the same industry and feel that a formal analysis is superfluous
• Managers may have undertaken a kind of implicit or intuitive cultural assessment that lacked documentation and objectivity and therefore defied replication
• Many simply choose to ignore potential conflicts even a rudimentary cultural assessment may reveal.

Cultural Due Diligence: The Process

Cultural Due Diligence can be explicit and measurable. It provides a discipline that compels senior managers to understand it own culture and to subject their gut perceptions and conclusions to tough scrutiny as well as to recognize culture as a critical ingredient in deal success.

Indeed, it takes a fair amount of courage for leadership to submit their preconceived notions of their own corporate cultures, or that of their prospective partners, to such a test. Moreover, if conducting a rigorous cultural assessment up front might be regarded as courageous, failing to do so could conceivably be considered a breach of fiduciary duty, particularly if a deal turns sour.

Source: Accenture / Mergers & Acquisitions: Irreconcilable Differences)

The procedures of Cultural Due Diligence cannot be “owned” in the way that accountants and lawyers own the statutory preserve of Financial and Legal Due Diligence. There is, however, a strong case for external specialists to conduct this work in close liaison with internal teams, as is the case with conventional due diligence. This ensures rigor of methodology, impartiality, and also adherence to agreed objectives and deadlines. Often, this team, or portions of the team, can transition to the integration process to insure continuity and accountability.

• Obtaining an impartial view of the organizations being merged in order to maximize the business benefits deriving from the deal
• Developing an integration plan that insures a rapid and successful merger

It is the task of Cultural Due Diligence, core areas include an objective view of:

• Profiles of senior management and their actual philosophies and styles
• The management and employees of an organization
• Talent
• Organizational structure
• Historical and projected headcount
• Personnel turnover patterns
• Operational patterns
• Compensation arrangements
• Organizational culture
• Industry culture
• National/regional culture
• Leadership style
• Corporate values
• Interaction among departments and divisions
• Brand values
• Knowledge behavior
• Market position
• Position of the client
• Training
• Sales process
• Territory and account management
• Customer relations
• Sales performance against market indicators
• Assessment of product compatibilities.

The following lists a sampling of the most crucial cultural due diligence questions:

Acquisition

• Why do you want to buy the company? What is the objective?
• What do you expect to gain?
• What makes the target company attractive – product, management, operations, financial, sales, subject matter expertise, people, products, strategic value, etc?
• How did they get where they are?

Values

• How are values defined and lived in practical terms?
• What are the official values of the organization to be acquired?
• What are its unofficial values?

Perceptions

• How do employees perceive their own company?
• How do they perceive the other company?

Procedures

• On what basis are decisions made (top-down, consensus-based, rapid, slow)?
• Is the organization relationship-focused or deal-focused?

Motivators

• How are managers motivated and rewarded?
• How are employees motivated and rewarded?

Uncomfortable questions

• What is regarded as absolutely unacceptable behavior?
• What subjects are regarded as taboo?
• Who is likely to embrace change, and who to obstruct it?

Sales

• What are the market and industry variables and trends?
• How are products and services presented to the marketplace: as commodities or value-added?
• What are the customer service dynamics?

Cultural differences can manifest themselves in the way people dress, communicate, use e-mail, and make decisions and more. The irony in all this is that such diversity can benefit the new organization, but only if it is fully harnessed. The most successful companies make concessions and combine the strengths of both companies to develop a new organization. And that must begin in the Cultural Due Diligence process.

Cultural Due Diligence was created to meet the growing need for a comprehensive “user friendly” process for assessing and analyzing organizational culture and also for integrating and transforming cultures successfully.

Summary

by Sarah Richmond

The media is filled with reports of the red hot merger-and-acquisition market. In the technology sector in particular, the volume and transaction value of 2007 M&A deals are both forecast to approach levels not seen since 2000. And despite improvements in the IPO market in recent years, M&A remains the liquidity event of choice for venture-backed companies.

These trends bode well for entrepreneurs hoping for a sale to a strategic buyer. However, for many of these aspiring sellers, a deal will never be concluded even though their business’s fundamentals are solid and buyer interest is strong. These “M&A casualties” occur because too often entrepreneurs do not exercise sufficient planning, realism and creativity.

An early mistake that sellers make is not having a realistic picture of how much their business is really worth. Much as many parents overestimate the intelligence and beauty of their own children, many founders overestimate the value of their own company, causing them to expect an unrealistic price. If you are a seller thinking about your exit, finding comparables in the marketplace will help you arrive at a realistic valuation. Much of this type of data is available online, and there are also outside advisers who can assist you.

Even realists sometimes find that their expectations are out of sync with a buyer’s willingness to pay, so thinking of creative solutions that can bridge the gap is important. One solution that is frequently employed is an earnout, which defers some of the sale price to future payments, which are contingent on sales targets, product developments or other milestones. An earnout satisfies the seller’s desire to be compensated for the expected future value of its assets, while also satisfying the buyer’s desire not to overpay for value that has not yet been realized at the time of the sale. However, sellers should be mindful that earnouts are only successful for the seller when very careful attention is paid to the structuring of the earnout when negotiating the deal.

The due diligence process is another contributor to deal failure. Major problems result when a seller fails to disclose important information about the company, and this information is later ferreted out by the buyer or its attorneys in their due diligence review. This can result in a purchase price reduction midstream, or even the suspension of negotiations. At the very least, because the “trust factor” has been impaired, the buyer will now feel the need to dig deeper and spend more time on due diligence than they otherwise would have.

Entrepreneurs can help smooth the way by doing their own due diligence on their company before the negotiations even begin. This will provide an opportunity to fix problems in advance, and even if this is not possible, at least it allows the seller to frame the issue for the buyer with the appropriate context, while retaining the buyer’s trust.

Many things outside the entrepreneur’s control can kill a deal midstream, and reducing the time-span of the due diligence period minimizes the likelihood of these events occurring. Priorities at the acquiring company may change during the process, making the acquisition seem less compelling. In addition, market conditions can change at any time, and a drawn-out process is the seller’s enemy.

Lastly, the acquisition period is an intense and distracting time for the entrepreneur and the company’s senior management team. Since a significant amount of time and effort is typically required to negotiate the deal documents and coordinate the due diligence review, many of the seller’s key people may not be able to focus as tightly on their day-to-day responsibilities. If this impairs the business’s performance leading up to the closing, the buyer will get nervous and the acquisition itself may be jeopardized. Management should be sure to keep its eye on the ball and continue to focus on running the company despite the distractions of the deal.

Deals fall through for a number of reasons. Anticipating the types of things that can go wrong, and working to address them with creative solutions, will contribute to ultimate deal success.

Sarah C. Richmond is a partner at Gesmer Updegrove LLP, a Boston law firm focused on entrepreneurial companies and their investors. She can be reached at sarah.richmond@gesmer.com.