There is a common thread that runs throughout much of the M & A Process. It is called Due Diligence. Due diligence is a very detailed and extensive evaluation of the proposed merger. In
An over-riding question is - Will this merger work? In order to answer this question, we must determine what kind of "fit" exists between the two companies. This includes: Investment Fit - What financial resources will be required, what level of risk fits with the new organization, etc.?
Strategic Fit - What management strengths are brought together through this M & A? Both sides must bring something unique to the table to create synergies.
Marketing Fit - How will products and services compliment one another between the two companies? How well do various components of marketing fit together - promotion programs, brand names, distribution channels, customer mix, etc?
Operating Fit - How well do the different business units and production facilities fit together? How do operating elements fit together - labor force, technologies, production capacities, etc.?
Management Fit - What expertise and talents do both companies bring to the merger? How well do these elements fit together - leadership styles, strategic thinking, ability to change, etc.?
Financial Fit - How well do financial elements fit together - sales, profitability, return on capital, cash flow, etc.?
Due diligence is also very broad and deep, extending well beyond the functional areas (finance, production, human resources, etc.). This is extremely important since due diligence must expose all of the major risk associated with the proposed merger. Some of the risk areas that need to be investigated are:
- Market - How large is the target's market? Is it growing? What are the major threats? Can we improve it through a merger?
- Customer - Who are the customers? Does our business compliment the target's customers? Can we furnish these customers new services or products?
- Competition - Who competes with the target company? What are the barriers to competition? How will a merger change the competitive environment?
- Legal - What legal issues can we expect due to an M & A? What liabilities, lawsuits, and other claims are outstanding against the Target Company?
Another reason why due diligence must be broad and deep is because management is relying on the creation of synergy values. Much of Phase I Due Diligence is focused on trying to identify and confirm the existence of synergies between the two companies. Management must know if their expectation over synergies is real or false and about how much synergy can we expect? The total value assigned to the synergies gives management some idea of how much of a premium they should pay above the valuation of the Target Company. In some cases, the merger may be called off because due diligence has uncovered substantially less synergies then what management expected.