Beyond Financial Due Diligence, By Cary Tutelman

tutelmancaryBeyond Financial Due Diligence

By Cary Tutelman

When companies are considering acquiring another company, they do extensive due diligence. They analyze balance sheets, income statements, debt history, customer lists, physical assets and equipment, the product and/or service offerings, etc. This is done to make sure that the buyer knows what they are buying.

However, there is another aspect of due diligence that is typically not done. I call it the non-financial audit. This is an analysis of the organization: its strengths and weaknesses, biggest needs, strength of management, culture, values, work environment and impact of a sale on customers and employees.

Mark’s Story

I was hired by a company to do a non-financial audit. My client was interested in going beyond the financials and getting an analysis of the organization. Here are the highlights of what I found:

Mark, the owner/entrepreneur/President, maintained all the relationships with the key customers. The customers didn’t know anyone else in the organization except a few customer care employees who they dealt with exclusively by phone. The key customers told me that they trusted the President and if he left, they had no reason to continue buying from the company because their loyalty was to the President, not the company.

 

Mark told me that he was only willing to remain with the company for 30 days after the sale. Then he was retiring. He would not accept any consulting contract beyond the 30 days. My conclusions: the financial health of the company was at stake when the Mark left and the new owners should expect significant drops in revenue right away.

– Mark was a typical entrepreneur with the typical command and control style of management. He made all the critical decisions and everyone else did what they were told. The managers were weak, untrained, underdeveloped, not really involved in management matters and took no initiative to improve the company. The employees were complacent and set in their ways. My conclusions: The new owners couldn’t rely on management for guidance or leadership and it would take a massive effort to change a system and the culture that had been build over 30 years.

My recommendation to the client: Don’t buy this company. Although it looked good financially and the market and products were sound, the overall risk was very high and the probability of failure was too great. My client bought a different company.

Non-financial audits are critical to the due diligence process and provide the buyer with a vivid picture of what “life” would be like if they completed the purchase. Yes, some buyers have told me that they can muscle through any organizational situation as long as the company is financially strong. I think this overconfidence is a mistake. A savvy buyer wants and weighs all pertinent information about a possible acquisition. That way, they will make a well-considered decision.

Cary has been a business consultant and the owner of CJT Company since 1981. He works with closely held and family owned businesses in transition. He guides them through the complicated web of ownership, management, board and family issues that transition brings.

Cary is a co-author of The Balance Point: New Ways Business Owners Can Use Boards, a book written specifically for owners of closely held and family businesses. It clarifies what owners do, what boards do and when they are needed and how owners, boards and managers can work together. Cary is a co-founder of The Board School, which helps business owners understand how to use boards in running and transitioning their company.

Cary J. Tutelman CJT Company Phone: 952-941-8864
Email: cary@cjtco.com
http://www.tutelmanconsulting.com

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Got a different point of view, want to play devil’s advocate, or just think we’re all wet? Post your experiences or examples.

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3 thoughts on “Beyond Financial Due Diligence, By Cary Tutelman

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  1. My opinion is a bit diverse as I do believe that high quality financial due diligence should pick these issues up…for example when analysing customer portfolio, operating cash flows, working capital etc… gathering an understanding on the business underlying numbers should always be a “must” and good practice
    However high quality due diligecne are not dependant on the consultant’s name/brand which carries this out…but people are the key factor.

    In addition by combining commercial due diligence (on future performances – forecast and busienss plan) such risks should be significanlty mitigated

    Regards,
    Matteo

  2. Great topic Cary! For nearly 10 years I have watched, been a part of, and an advisor on both the buy and sell side. My level of frustration was palpable! Far to much focus on numbers, balance sheets, forcasts, futures and EBIDA lead to bad deals.

    I see companies with products so superior to competitors, so disruptive, with incredible and significant differentiation, that have terrible financials because they have made mistakes in sales strategy, PR, marketing, etc. and none of this matters-M&A has become all about buying revenue, buying customers, and buying marketshare-and if not either of those, transactions to eliminate competitors;rarely are deals strategic anymore.

    In my experience M&A has become robotic.

  3. As underwriters by trade we have to look at the “if then” elements of these transactions prior to delivering a lender to the deal. For example if an acquisition and/or organic growth initiative results in a company say tripling its revenue, we cannot in good conscience recommend to any lender a request for funding of that growth without satisfying the criteria that is critical to the achievement, control and maintenance of the growth. It is to agree with Deborah to go “beyond the balance sheet”.

    We believe this is the future of financing these types of transactions especially in the 5 – 50 million range where CEOs like Mark are going to live, the companies are much more people dependent than systems dependent.

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