Businesses aspiring to get value from an M&A deal should look beyond financials with due diligence.
While more than half of Australian corporates (54 percent) consider due diligence the most important factor in realising value in mergers and acquisitions (M&A), just 13 percent rate cultural fit as a critical element, according to KPMG’s 2017 Evolving Deals Landscape survey.
These findings are surprising given how crucial culture is to the success of an M&A deal. Cultural clashes can seriously undermine one of the most valuable assets in a deal – human capital. “You can see human capital leave the organisation very quickly when employees don’t see eye-to-eye with the basics of the culture and the way it works,” says Craig Mennie, Partner in Charge, Transaction Services, KPMG.
Conversely, cultural differences can be one of the M&A transaction’s greatest strengths and a core component in creating value. Mennie says when you acquire an organisation that is more agile than you, what you’re really targeting are cultural differences, their innovative approach along with its culture of ‘try, test, fail and move on’. “Those cultural differences may actually be one of the gems you are looking for.”
Cultural considerations should be an inextricable part of a deal’s due diligence and its integration planning. Otherwise, there can be a failure to properly understand where and how value can be created, and important attributes may be disregarded or lost along the way. Stefanie Bradley, Partner in Charge, People and Change, KPMG, says the issue is clear: “culture is a leading cause of M&A integration failure”. “With the benefit of hindsight everyone can see this. However, the root of this failure is at the very beginning of the M&A process where too little attention is given to people and culture during deal evaluation.”
One of the reasons culture and human capital are often overlooked in due diligence is that they’re not easily quantifiable, says Ronan Gilhawley, Partner, Global Strategy Group, KPMG. “Given the time pressures of transactions and the typical focus of deal teams, there’s a tendency to boil down these transactions to aspects that can be easily quantified.” Yet, he adds: “If you view diligence as a strategic exercise, you have to think about the human capital of the business.”
It comes back to identifying your reason for the deal in the first place: “An acquisition is not a strategy. It is a means of executing your strategy,” Gilhawley says. Without an overarching strategy, you don’t have a true north or guiding principle as to how you manage the acquisition, including the due diligence process.
There’s no reason why a company’s human capital – its people – can’t be adequately assessed, Bradley says. "Leaders have at their disposal effective tools to identify cultural differences and people issues that have the potential to derail integration – too few do this up-front which is why deals fail.”
One example is a performance framework, which can offer important insights by comparing two companies’ remuneration structures and incentives. Gilhawley worked on a deal where one organisation incentivised its sales people on the initial value of the contract sold; the company it was acquiring incentivised its people on the lifetime value of its customers.
“If you work backwards, you can infer significant differences in the culture of the sales forces and how they behave as a consequence,” he says.
Due diligence among Australia corporates varies considerably in the consistency with which it is undertaken, Gilhawley says. He explains that among the largest companies there’s a growing awareness of the need to look at multiple determinants in diligence, whereas those at the mid-tier level require further education.
Gilhawley adds: “There’s an increasing recognition – certainly among more sophisticated buyers involved in larger transactions – that what you’re actually buying, in part, is the capability of the organisation. You’re buying the human capital, and you need to pay as much attention to that aspect as you do to the operations and financials of the business.”
On the other hand, he says, “as you move into retail, consumer, industrials and the mid-market, which represents the largest volume of transactions in the Australian economy, you tend to find a far greater prevalence of people doing deals where there’s an awful lot of subjective commentary going into those deals.”
Gilhawley adds: “You have this issue of victor mentality, or victor bias, where they feel they already know the target. Therefore, they may not do sufficient due diligence to check whether their understanding of the target is actually correct.”
Bradley adds that as organisations look to joint ventures and alliances to drive value, it is even more critical for leaders to consider cultural fit.
“To reap the benefits of these relationships, teams from different backgrounds need to work together effectively. Understanding your culture and that of your potential partner at the outset is non-negotiable.”
Due diligence must go beyond the company and its people. “Due diligence should also be about giving consideration to the market in which the business operates – its customers, competitors and how it’s commercially positioned within that market.”
While this approach is well established in the United States and the United Kingdom, it has yet to gain traction here, says Gilhawley. “People might know the market, but don’t necessarily know the commercial and competitive positioning of the target within that market. They base their articulation of the deal value on what they think the position of the business is. Once they take control of the business they find out it’s actually a little bit different to the way they thought it was to begin with.”
This tendency to favour preconceived notions is Gilhawley’s rationale for the small number of companies that look to external advisors to conduct operational due diligence. In KPMG’s survey, 15 percent of respondents chose to do so, while few engaged advisors to conduct commercial due diligence (24 percent) or to assist with integration planning (13 percent) during deal processes.
Says Gilhawley: “It comes back to bias. People think they know their organisation and industry best, so they don’t need someone else to tell them.”
What these companies forget is that there is so much that can be garnered about any given company from data and analytics. Mennie says without data and analytics, you might believe that sales are moving in a particular direction, but the facts could speak differently.
“By using data analytics you can determine whether this trend is being caused by one particular customer, 100 different customers or some other factor.”
Technology can be a boon for due diligence. Social media alone offers important insights. Says Mennie: “The ability to get a real understanding of what the customers and employees are thinking about the brand and the organisation can certainly round out the insights into where that particular company is positioned in terms of customers and staff.”
Gilhawley agrees: “People can discount social media because it’s all about perception not reality. However, the challenge for consumer-centric businesses is that perception rapidly becomes reality if it’s not managed.”