By Joseph Rahal

A discussion about developing sales compensation plans that work.

Consistent with everything in life, careful thought, preparation and a clear objective are essential for success. Designing a successful and effective compensation plan is no different. Good compensation plans must be:

• realistic
• simple to administer and understood by all
• motivating
• an integral part of the over-all sales strategy and sales management process

Compensation plans are as individual as each business. There is no “one-size-fits-all”. There are, however, a set of standard fundamentals within each business from which all compensation plans should be developed. The components of the plan must be aligned and consistent with these basic fundamentals. When initiating a compensation plan, business leaders must start with a clear understanding of:

1. their business model and philosophy
2. their business objectives
3. the right people with the right skills in the right place and what is expected of them
4. their goals, expectations, measurements and the accountability system(s)
5. the performance management program(s)
6. their culture (do sales managers help develop skills and talents of reps; is it a team environment, etc)

In addition to the fundamentals listed above, several key variables enter into the formulation of compensation plans:

• over-all sales strategy
• sales management and its role
• the maturity of the business
• the profile of sales force
• types of sales channels
• the marketplace
• short term needs and goals versus long term
• organizational structure insuring people are assigned properly with clear, well communicated objectives and are incented and paid accordingly
• pricing and margin
• client incentive programs
• what results are covered by salary / draw versus what results are considered exceeding expectations
• total benefits (auto, expenses, cell phone, healthcare, retirement, etc)

Once a compensation plan is in place, it is not an advisable strategy to constantly change, and/or tinker with, compensation plans; but at times, change is necessary. Plans do not have to change in totality, but rather adjustments can be made such as:

• number of components in the plan
• assigned weight on each component
• individual goals versus team goals
• focus of the commission  (gross profit, margin, new accounts, retained accounts, retained dollars, add-on sales, cross selling, internal referrals, etc)
• timing of when commissions are paid
• other rewards (trips, awards, etc).

Development of an effective compensation plan is a process that takes into consideration the company’s sales objectives and strategies and aligns the plans components with the key business fundamentals. The effectiveness and success require thought and planning.

By Bonni Carson DiMatteo

Often motivated by business “burn out”, a strained business climate or the image of an endless vacation, founders begin to consider selling their business. It seems like a perfectly left brain solution to frustration, malaise or boredom. They may talk to their spouse about how they are burned out or want to extend their winter vacation in Naples, or have more time to visit the grandchildren, and before you know it they are talking to their accountant, lawyer, financial planner or a business broker about selling their business. Their business advisor helps them crunch some numbers, estimate how long it might take to sell the business in the current environment and to determine the value proposition. When all the signs point in the direction of “Sell”, why do some businesses fail to execute? Founder reluctance and a founder centric culture will derail the ability of many businesses to “close the deal”.How can these companies change their mindset so that they can implement a successful exit strategy? Which advisors are best equipped to address the right brain thinking that can often instigate or derail the sale?

Over the last several years, exit planning advisors have been thwarted by a business climate marked by declining sales and earnings, shrinking bank credit, and a poor economic outlook. Consequently, there have been few buyers in the market since the beginning of the financial meltdown in 2008. With cash reserves built up over the last 2-3 years, and gradual improvement in economic conditions, companies are showing more interest in buying new businesses. The availability of buyers is estimated to exceed that of sellers in 2011. As more deals are executed, company valuations are expected to increase. This appears to indicate a great opportunity for companies to jump into the market and sell their business.

Stalled at the Altar

The companies most likely to stall at the altar are those that have what we call a “founder centric culture”. These companies, often started by boomers 25-40 years ago, have been operating for more than a generation. If they do not have a succession plan they are looking for some way to capitalize on their biggest investment, their business. What obstacles are inhibiting these companies from successfully completing a sale? Many attribute the failure to execute the sale to factors such as disagreement on price and market conditions. Buyers looking for a good investment may back away from companies that have an immature internal structure and a founder centric culture. Often, the emotional founder ambivalence and founder centric culture of the company are the biggest hurdles to overcome.

Symptoms of Founder Ambivalence

Founder ambivalence is marked by:

• Difficulty with following through on action plans suggested by advisors.
• Being preoccupied by a stream of company crisis that distracts from the big picture.
• An over worked and stressed founder who has no reason to focus on the big picture.
• Lack of a clear personal and family strategic plan to take them into the next 10-20 years
• A clearly defined sense of purpose and mission beyond the business

• Company leadership deficits
• Process deficits
• Culture deficits

The business is the founder and the founder is the business. Therein lies the challenge. Their greatest strengths are often their greatest weaknesses. In founder centric companies, you often find a Founder who is actively involved in working in the business, but not on the business. They are a key rain maker or customer evangelists. They are what we call a Founder Hero because they are often the only one who can serve customers right. There are frequent fire drills and often the founder is the one rescuing the day.

It is what Michaels E. Gerber refers to in The E MYTH as the conflict that rages among the three hats of entrepreneur, manager, and technician. They may be the chief decision maker and process saboteur; they have no succession plan or strategic plan; They have no advisory board; They simply meet each day’s challenge; keep a steady pace and do things in ways that have worked in the past. They see no reason to have a vision or a plan. The company mantra is “we’ve always done it this way”.

Buyers are wary of a lack of process and systems that can survive beyond the founder. They may, or should, have a certain skepticism that this founder will be able to let go of something that gives him or her such a sense of identity and purpose, or that staff, vendors and customers will be able to transfer their loyalty to a new owner.

Company/Leadership Deficits

In the founder centric company there are noticeable leadership deficits. While the founder is clearly the culture creator, and larger than life in many ways, the sense of leadership dwindles from there. Often there is a key executive who has been with the company almost as long as the founder and follows his or her path. There are little to no leadership/management competencies or development. If there is a management team, it may be one that does not function effectively.

Buyer Red Flags

Buyers may be cautious of such leadership vacuums, knowing that without the founder there is little capacity to decide, execute and achieve results.

Process Deficits

In founder centric companies there are often great ambiguities among people in terms of roles and responsibilities. This is further complicated by the lack of a systemized process that allows for efficiency and success. The firefighting caused by last minute crisis ultimately results in the erosion of profits. To further compound the problem, decision making often occurs only at the top and there is no accountability throughout the company.

Buyer Red Flag

Buyers observe this cautiously. Process improvement and tightening may create an opportunity to improve profits, but the current state of the organization points to weakness.

Culture Deficits Are Created By The Leader/ Founder

In founder centric companies there are often extreme levels of morale and engagement. Larger than life personalities often create a tightly woven family of employees. They are loyal to the founder and the founder is loyal to them. There are blessings and curses with this.

As the company grows it is difficult to change the guard and the guard is not always adaptable to change.

The culture is often marked with crisis du jour, stress, complacency, silos, no sense of accountability. There are challenges with retention/talent attraction, an aging work force, lack of diversity, change resistance, and no sense of vision of the future due to strategic plan deficits.

Buyers eye this phenomenon guardedly. They understand that if the founder leaves there may be a vacuum too big to fill and the loyalty will soon dissipate. Buyers are looking for a company that can evolve beyond a company founder. As buyers observe the challenges of a founder centric company often the financial value begins to diminish.

What can a founder and their advisor team do to reshape their company and make it buyer friendly?

Steps In Evolving From A Founder Centric To A Buyer Friendly Company

Buyer friendly companies have evolved from a founder centric culture by implementing best practices in leadership, management, organizational development and process/ profit focus. They differ from founder centric companies in that they focus primarily on working ON the business rather than IN the business, utilizing a more systematic business process. The following steps are needed to evolve the company from founder centric to buyer friendly.

Key Advisors Needed At Each Step

To execute a sale that maximizes the company value, key advisors must work together and in tandem to help reset the company’s GPS.

1. Founder Readiness: Creating A Legacy And Resetting The GPS Personal Strategic Planning:

The execution of a sale begins with a focus on legacy and personal strategic planning combined with corporate strategic planning. This enables the founder to create a vision, mission, values, and goals for him/herself, as well as leaving the business in a position that commemorates their legacy of success.

ADVISOR TEAM: Management Consultants; OD/Coach; Recruiter

The company and the founder need to prioritize building a leadership/management bench by identifying key leadership capabilities and competencies, and through training or coaching in house managers or recruiting new blood. There also needs to be some team building to solidify a cohesive team to set and execute goals and to develop a new organization chart that clearly defines roles and responsibilities.

ADVISOR TEAM: Business Coach/ OD Consultant Corporate Strategic Planner

As with a personal legacy, the founder and executive team need to create a strategic plan that closes the gap of vision and current reality and sets executable goals for:

• Decentralized decision making
• Management competencies
• Process improvement
• Innovation
• Increased revenues

It is necessary to set the stage for growth and operational effectiveness that will attract the right buyer at the right price. The discipline of executing on a 1-3 year plan will much better position themselves for a good sale.

ADVISOR TEAM: Business Coach, Organizational Development or Management Consultant

Help create the change necessary to maximize the volume of the business. Heath & Heath’s book, The Switch, is a good reference for this. This step is not only a process improvement leap, but a mindset and cultural leap as well.

ADVISOR TEAM: Financial Planner/Accountant to help owner finance the future

Understanding what the owner needs, what they have, and closing the gap

ADVISOR TEAM: Lawyer, Coach, Financial Planner, and Accountant

Addressing the 4-legged stool: the legal, financial, long-term financialgoals and the personal legacy the owner wants to create

7. Finding The Buyer:

ADVISOR: Broker

Identify the new value of the company and determine the strategies for selling and finding the best buyer.

ADVISOR TEAM: Lawyer, Accountant, Coach, Broker, Financial Planner.

This is where seller ambivalence most rears its head. The collective input of all advisors, particularly the coach who best knows the right brain challenges needed to help take the founder to the altar.

Both advisors and sellers can benefit from the lessons learned from implementing these steps. Evolving from an Entrepreneur to Founder owner to Leader is not an easy or fast process. However this can be accomplished in 6-12 months once the founder mindset is fully engaged in the process and the outcome. Specialists in behavioral economics and organizational culture are essential to unbind the organization and leader from a founder centric mindset and homeostatic behavior. Experts in this field are an essential part of the Exit Planning Team that provides right brain balance to the left brain experts.

A sale that maximizes the value of the company can best be reached when the first 7 steps are completed. As the founder resolves their ambivalence they become more confident and committed to the sale. In turn, buyers respond with a similar confidence and enthusiasm. It is only through creating the changes inside and outside the founder and the company that the sale can be fully achieved at its greatest value and without last minute ambivalence that can undermine the final signing of the agreement.

Copyright Bonni Carson DiMatteo 2011 Atlantic Consultants 27 Mica Lane, Suite 106, Wellesley, MA 02481 5

By Michael Oleksak

In the early days of my consulting practice, I met with the owner of a small manufacturing business. The owner had just learned he had inoperable cancer and confided that he would be dead in about six months. He did not have a succession plan but hoped his daughter, who was then 22 years old, would take over the business.  The owner wasn’t sure because he had not discussed this plan with his daughter yet.  Ultimately, the business owner turned to his accountant, who was also a close family friend, to oversee the transfer of the company to his daughter while the accountant stayed on as advisor. Because it was cancer, the owner had time to draw up a will and organize his estate.

His succession plan for the company, however, started with hoping his daughter would take over its management. His exit strategy had been determined by his health.

Prepare for Sudden Changes in Management or Ownership

Imagine you were this business owner’s commercial banker. Your small-business borrower drops this situation in your lap. Your first reaction is disbelief: This middle-aged man looks healthy. Then you become sad because you know and like this person.  But when you hear the owner’s succession plan is to hope he can leave the company to his young daughter, you wonder: “What experience does this just-out-of college daughter have?  Have I even met her?” This leads to more questions.

• How will employees react?
• How will customers react?
• How will you as a lender react?
• What is the future of this company?
• Will it stay financially healthy enough to repay the loan?

No question, the lender’s risk just went up. Should the interest rate rise as well? Is there a change of ownership clause in the loan agreement?  The owner’s terminal illness is not his fault. It is, however, his responsibility to prepare for eventualities like his own untimely death. His family, employees and company rely on his leadership and foresight to anticipate future issues.

By the same token, it is the commercial lender’s duty to ask tough questions to protect the bank’s position. Even if there is a change of ownership clause, you as the lender are in the same boat as your borrower. You want the company to succeed so the loan will be repaid or taken over at some point by another lender. No other lender will want to step in now unless the conditions can be improved with a defined succession plan along with increased collateral or financial support.

Understand the Owner/Manager’s Exit Strategy

Commercial lenders should address this risk by understanding the exit strategy of every owner/manager in their loan portfolios (if these owners even have an exit strategy).  The exit strategy will have a big influence on the strength of your credit as well as on the viability of your relationship with the company.

The exit strategy can lead to a conversation about whether the owner has a will and a succession plan. If the owner has not made a will, this could mean that ownership of the company’s shares is undecided or that the shares could land in the hands of under-prepared family members in case of the owner’s sudden death.

Case in point: Miami Dolphins owner Joe Robbie, a successful real estate attorney, did no estate planning before his death. His heirs had to sell the Dolphins franchise and Joe Robbie Stadium at fire-sale prices to pay estate taxes. The family fractured over the crisis, and Robbie’s legacy is not his successful real estate development career but the poor planning that harmed his family.

As a lender, you need to ask about an owner’s succession plan and whether the firm has the management depth and clear operational assignments to survive a surprising end to the owner’s life or incapacitation. A lender who asks these questions can prompt a business owner to develop a strategy and address shortcomings, thereby alleviating the lender’s concerns about unforeseen occurrences.

What are the possible outcomes for an owner-managed business besides the dire circumstances just addressed? Let’s look at two, both with different implications for the commercial lender: internal transfer and external transfer.

Internal Transfer

An internal ownership transfer could be (1) a sale to the management team, known as a management buyout; (2) a sale to employees via a tax-advantaged employee stock ownership plan (ESOP); or (3) a gifting of shares, usually to the next generation of the family, also with significant tax benefits. If the internal transfers are for less than 50 percent of the ownership shares of the company, the owner may stay in control of decisions and finances by controlling the voting stock.

Influence on relationship with lender. With an internal transfer, the lender should already be familiar with management if there is a change. With a management buyout, the lender should know the individuals taking over and must make a decision about whether the new team can lead the company despite the increased debt to finance the transaction. If not, the bank will ask to be paid out of the loan.

With an ESOP, the transaction will often be for less than the control of the company, a way for the owner to share with loyal employees by giving them an equity stake. A lender’s decision making should be the same, however, given greater debt on the books to finance the purchase. Gifting of company shares may be done in stages, so the current owner or management team may still be in control.

In all of these scenarios, what role will the current commercial lender play? No outside financing source will know the debt-service capability of the company better than the current lender, making it likely that the current lender will be the first invited to stay on to provide loans and services, including financing an internal transaction or ongoing operations.

All these scenarios could be subject to a change of ownership clause in the loan agreement, allowing the lender to opt out if not satisfied with the new ownership structure.

External Transfer

An external transfer would be a sale, either to a strategic buyer (such as a competitor) or to a financial buyer (such as a private equity investor). Because the external transfer will likely be for at least a majority of the shares, the owner will likely be out of the picture in a few years.

Influence on relationship with lender

With external transfers, it is likely that the private equity group or strategic buyer will have its own stable of lenders. By keeping the lines of communication open with the company and the prospective financing team, as well as expressing interest in taking at least a piece of the financing, however, the current lender may well have a role in the new loan or be kept on to provide some services.

Exit Strategy: Not Always Obvious

Commercial lenders are not often thought of as trusted advisors to a company’s business owners. Trusted advisors are generally the company’s CPA, attorney, and, sometimes, the owner’s investment advisor. The fault is not with the banker. Decades ago, the relationship was closer. However, successful lawsuits for lender liability cases have influenced lenders’ behavior. As such, lenders never want their actions to be interpreted by judges as having exerted undue influence over a borrower’s business decisions. Lender liability can result in big financial penalties against the lender.

For this reason, commercial lenders are often out of the loop when it comes to a critical factor influencing the strength and viability of their borrowers: the owner’s exit strategy. Much conversation between a bank and the owner-manager of a business focuses on the owner’s managerial role. It can be hard to get an owner to talk about ownership issues because these often require a discussion of personal and family issues. However, the owner’s exit strategy can have a huge influence on the health of the company and on the bank’s relationship with the company.

A good commercial banker provides numerous services to the owner-managed business, generating considerable fees for the lending institution. Apart from the fees and interest from the loan, the relationship probably also provides income for the bank from cash management services, trade services, account fees and balances.

Sometimes, when the lender is successful in engaging the owner in discussions of exit strategy, the loan and services may be lost anyway. Recently, a 12-store retail chain in the Northeast was sold to a large national retailer. Over the previous year, the lender had actively reviewed all the options facing the owner and the second-generation owners of the family business. In the end, the acquiror will pay out the family members for their shares, and the acquiror’s bank at the corporate level will take over the financing and services. Even with this outcome, the former lender had a good understanding of risk throughout the life of the loan and was able to anticipate some form of upcoming change.

Sources of Strategic Information

The lending officer typically meets regularly with the borrower’s chief financial officer, treasurer, vice president of finance, or controller to discuss the quarter’s results and trends. The lender can use these meetings to ask about ownership issues, including whether the owner has a will, who the beneficiary is regarding the company’s ownership, if there is a succession plan and whether or not there is an exit strategy. If the lending officer is aware of upcoming changes in ownership, the lender can protect the bank’s position as the preferred commercial lender.

The lender can help focus the owner-manager on the future by asking probing and thought-provoking questions about the owner’s will, succession plan and exit strategy. If the owner is reluctant to discuss these issues, the lender should take this as a signal that such plans may not exist.

If there is a board of directors, or board of advisors, the lender should ask these questions:

• Where will the business be in five years?

• Does the owner want to own the business in five years?

• Does the owner want to be managing the business in five years?

• Does the owner have a will?

• Who is currently the beneficiary regarding ownership of the company?

• Is there a succession plan if the owner gets hit by a bus on the way to work?

• Does the owner simply envision the spouse or other relative taking over if something happens?

Owners Want Their Businesses to Live On

Given the personal nature of these questions and their implied reminder of the owner’s mortality, these can be difficult topics to discuss openly. But the commercial lender is a key stakeholder in a business, and asking such questions protects the bank’s interest and capital.

Ultimately, most owners would like their businesses to carry on and thrive even after they are no longer active participants in it.

Creating and sharing details of a will, succession plan and exit strategy with their lender can help build toward a longer, successful existence for the business.

Michael Oleksak was a 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 increase value and prepare for exit. Contact him at oleksak@ trekconsulting.com.  www.trekconsulting.com

© Copyright 2010 Michael Oleksak. All rights reserved.

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.