What are the most overlooked areas of Due Diligence?
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Where do you think most organizations do not put enough time and effort in due diligence? How has this impacted the organization in a negative way?
In today’s world, IT is a critical part of any modern business, yet from my experience, the attention given to IT due diligence is still fairly minimal compared to financial DD, Commercial DD or operational DD.
Yet, in my opinion, the following questions are critical to get accurate answers to in order to move forward with a potential merger or acquisition:
– Does the IT organization contribute to the corporate value?
– Are the business applications scalable, reliant and up to date?
– Does the target operate a modern IT infrastructure platform free from any technology debt?
– Is the target’s security organization state-of-the art with strong cyber capabilities?These are just some questions for which a negative answer (or not knowing the answer at all) could lead costly and unplanned expenses during the integration phase.
Great question! One area where organizations often fall short in due diligence is in assessing Human Resource / cultural compatibility. Cultural due diligence involves understanding the values, norms, and working styles of the target company and how they align with the acquiring organization. When this aspect is not given enough attention, it can lead to clashes in leadership styles, communication breakdowns, and difficulties in integrating teams and processes. These cultural mismatches can create a negative impact on employee morale, productivity, and overall organizational performance. Additionally, overlooking cultural due diligence can hinder post-acquisition integration efforts and result in a lack of synergy and collaboration between the two organizations. Therefore, placing more time and effort into cultural due diligence is crucial to ensure a smoother transition and maximize the potential benefits of the acquisition.
Good question,
One area that we see are agreements that may exist with government entities. We see the customer contracts, vendor contracts etc. Often the target will have agreements with the local governments etc regarding Right of way of other area, that we do not discover until well after close and it not only could effect valuation, but operations as well.Due diligence processes can vary widely depending on the context (such as business acquisitions, investments, partnerships, etc.), but here are some areas that are often overlooked:
Cultural Due Diligence: Understanding the organizational culture and whether it aligns with your own values and operational style. This includes assessing employee morale, communication norms, and management practices.
Intellectual Property (IP) Audit: Ensuring that all intellectual property rights (patents, trademarks, copyrights) are properly owned, registered, and protected. This includes assessing any potential IP infringement risks.
Environmental Due Diligence: Assessing environmental risks and compliance issues related to the business’s operations, such as pollution, hazardous materials, or regulatory violations.
Cybersecurity Due Diligence: Evaluating the effectiveness of the company’s cybersecurity measures and identifying any vulnerabilities that could pose risks to data security.
Tax Due Diligence: Reviewing the company’s tax compliance history, potential liabilities, and any pending audits or disputes with tax authorities.
Customer and Supplier Contracts: Reviewing key contracts with customers and suppliers to understand the terms, obligations, and any potential risks or liabilities.
Regulatory Compliance: Ensuring the company complies with all relevant laws and regulations in its industry or geographic location.
Human Resources and Employment Practices: Assessing HR policies, employment contracts, compliance with labor laws, and potential liabilities related to employee claims or disputes.
Financial Modeling and Forecasting: Conducting a thorough review of financial projections and assumptions to ensure they are realistic and based on accurate data.
Insurance Coverage: Reviewing existing insurance policies to assess coverage adequacy and identify any gaps or exclusions that could impact the business.Most organizations often do not invest enough time and effort in conducting thorough operational due diligence. This oversight can lead to a lack of understanding of the target company’s operational efficiencies, scalability, and integration challenges. As a result, post-acquisition integration issues, unexpected operational costs, and disruptions in business processes can arise, ultimately impacting the organization’s ability to achieve anticipated synergies and financial performance. This neglect can result in financial losses, operational inefficiencies, and a failure to realize the full value of the acquisition.
Most organizations often overlook cultural fit during due diligence. This oversight can lead to integration issues, low employee morale, and high turnover, ultimately disrupting operations and eroding the value of the acquisition. Ensuring cultural alignment is crucial for a smooth transition and long-term success.
The single most important asset someone is purchasing is the management team. From my experience on the buy side, the most overlooked element is talent gaps in management. Particularly with small to middle market companies. Is the buyer prepared to recruit executive talent or add to the team? They must be prepared to make that decision. How closely will the buyer manage the organization? The evaluation of management talent goes beyond the resume. Leadership evaluation comes from the plant/company tours and talks with the CEO and the team. Asking the right questions in a way the determines the desire and ability of the team to grow the company and integrate (if applicable) with the buyer. I’ve been lucky enough to have CEOs be candid about their management team members, but never count on it. This is one of the dark arts of M&A. You have to be able to read people and determine if they can take the company to the next level.
Most overlooked areas of a company due diligence process in my opinion are Operational and Human Resources/Culture due diligence.
Very often only limited due diligence is undertaken in mentioned areas, this can lead to serious problems in post-transaction integration and change management.Many organizations often overlook cultural and human resources aspects during due diligence. While they focus heavily on financials, legal compliance, and operational factors, they might miss how differences in company culture or unresolved HR issues can lead to integration problems post-acquisition. For instance, misalignment in corporate culture can result in key employees leaving, reduced morale, or clashes in management styles, which negatively impact productivity and the overall success of the merger or acquisition.
I like the IT aspect: having seen my current employer acquire a company 5 years, I can tell from my own experience that not doing a thorough IT DD can lead to extra costs, delays in your anticipated M&A timeline and quite some dissatisfaction. And at the end, the employees suffer, and if worse comes to worst, the sales will. It is essential to understand:
– which systems must merge and must be integrated after the acquisition?
– and how much will that cost?
– And what are the risks of delays in that, or the risk of unforeseen costs?Cultural fit between the acquiring company and the target.
Cybersecurity (IT infrastructure, cyber risk management).Insufficient review of IP assets and potential legal issues can result in litigation and loss of market position, as seen in various tech acquisitions where IP rights were contested post-deal.
In smaller deals, due diligence often overlooks the critical role of crucial employees beyond the owner. While the focus typically centers on the owner as the primary decision-maker and connection-holder, it’s the key employees who drive the day-to-day operations and sustain the business behind the scenes. Properly evaluating their contributions, skills, and retention risks is essential to understanding the company’s total value and operational stability.
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