Soft Due Diligence
Once a merger or similar transaction gets underway people get caught up in counting things typically in terms of current cost in the manner prescribed by traditional accounting; how many, what liabilities, and expected synergies, and so on. Buyers look less at the potential for value destruction caused by items not disclosed in the financial statements or the resources to create value. It is these “soft” considerations that account for why many business combinations fail to deliver their promised value.
Buyers are hard to find and it takes time to consummate a transaction. Owners who are not permanently “sale ready” won’t realize top sales value and they reduce the odds of successful closure. High-quality companies stand out from the crowd and should be conducting their own pre-sale “due diligence” to forestall these limitations.
Buyers need to identify potential value killers before the transaction’s closure so as to be prepared to take appropriate remedial steps, seek a price adjustment or both. Soft due diligence alone is unlikely to reveal a cause for aborting a transaction.
People are usually critical to a transaction and make or break its success. After all, wasn’t it the employees that made the target so attractive in the first place? Buyer and seller "Soft due diligence" should include:
Talent Assessment - key individuals not necessarily executives, that make the business a success who may include engineers, technicians, those with proprietary product knowledge or technical know-how, or just unofficial leaders who influence the opinion of others or reflect the essence of the organization's culture need to be identified and incentive plans to encourage their retention before, during, and after the sale implemented.
Leadership Voids – how involved is the founder in day to day activities and how many key positions are occupied by other family members. Is there a viable succession plan or cross-training plan to secure backup for these employees following close.
Cultural Assessment –how does the company operate? A successful transition will not depend on who has the best leaders but recognizing and responding to the differences in how work is organized, carried out, and instructions communicated. What are the learning style preferences, how do people receive performance feedback and made to feel engaged?
Future State – communicate, communicate, and communicate to maintain engagement before, during, and after the close how processes are likely to change and whether the buyer’s practices, the seller’s, or neither will prevail. All employees should be provided with what they need to be successful in their role. Understanding cultural dynamics will aid the achievement of the transaction and desired performance outcomes.
Labor Unions– are there collective bargaining agreements, outstanding grievances or any organizing activity in process? Will a transaction obligate the buyer to assume the terms of contracts effectively, ensuring that an employee experiences no change in their employment.
Employee Handbooks– should be up to date and compliant in all relevant jurisdictions with any pending charges or investigations disclosed along with the records of any employee hotline, employee complaint, and tracking mechanism. HR compliance is a serious consideration.
Executive Agreements– are there severance obligations, restrictive covenants, or “change in control” triggers and who will assume payment obligations? Compensation and benefits should be market competitive and benchmarked against appropriate competitors.
No one can envisage the upside potential of a transaction better than the sponsor and our role whether working for buyer or seller is to help deliver that upside and avoid the underachievement that plagues many transactions.