Due Diligence

Due diligence all too often becomes an exercise in verifying the target's financial statements rather than conducting a fair analysis of the deal's strategic logic and the acquirer's ability to realize value from it. Seldom does the process lead managers to kill potential acquisitions, even when the deals are deeply flawed.

What can companies do to improve their due diligence?

In "When to Walk Away from a Deal," Harvard Business Review, Vol. 82, No. 4, April 2004, authors have taken a close look at twenty companies—both public and private—whose transactions have demonstrated high-quality due diligence, and calibrated the findings against their experiences in 2,000-odd deals that they have screened over the past ten years.

They have found that successful acquirers view due diligence as much more than an exercise in verifying data. While they go through the numbers deeply and thoroughly, they also put the broader, strategic rationale for their acquisitions under the microscope. They look at the business case in its entirety, probing for strengths and weaknesses and searching for unreliable assumptions and other flaws in the logic. They take a highly disciplined and objective approach to the process, and their senior executives pay close heed to the results of the investigations and analyses—to the extent that they are prepared to walk away from a deal, even in the very late stages of negotiations. For these companies, due diligence acts as a counterweight to the excitement that builds when managers begin to pursue a target.

All the successful acquirers were found to be consistent in their approach to due diligence. Although there were idiosyncrasies and differences in emphasis placed on their inquiries, all of them built their due diligence process as an investigation into four basic questions:

What are we really buying?

What is the target's stand-alone value?

Where are the synergies—and the skeletons?

What's our walk-away price?