The Up-front Work Matters
Due Diligence is Essential in Any Merger or Acquisition

Target Audience: Manufacturing and Development Companies, M&D industry, Companies with Merger and Acquisition Interest, Accountants and Consultants

When a manufacturer wanted to expand its geographic reach, it acquired a smaller competitor in a neighboring state. The acquisition went smoothly, but postmerger integration was a nightmare. The cultural differences between the two companies were dramatic — so dramatic that they threatened to destroy the new entity before it even was fully launched.

Hindsight is 20/20

Looking back, the acquiring company realized that it had lost sight of one of its fundamental requirements in its zeal to seal the deal: The target company must have a compatible culture. After months of slow shipments and disgruntled employees, the management team was able to get the merged company on somewhat firmer footing, but camaraderie was never fully restored to premerger levels.

This fictitious tale easily could have had a less positive outcome. But the integration problems also could have been avoided had either company done adequate due diligence early in the acquisition process. Mergers and acquisitions have become a way of life in manufacturing, but they depend on up-front work to succeed.

Scrutinize finances and liabilities

The first thing that comes to mind when someone says “due diligence” is finances. You must know how a company has previously performed financially, as well as its current assets and liabilities, earnings and expenses, and other relevant information.

But your financial scrutiny should go beyond the usual. If a target company has recently reduced spending in areas such as research and development or advertising, ask why. Sometimes such reductions are efforts to improve perceived value.

Hidden liabilities can be another risk. You’ll want to know about potential exposure to environmental risks (such as asbestos), possible legal claims from disgruntled employees or unhappy customers, and any other hidden minefields. Such liabilities can derail a promising transaction or significantly affect the purchase price.

Ask tough questions

Even though financial due diligence is critical, it isn’t enough by itself. There are many other areas of a manufacturing company that merit scrutiny before you begin buying it — or being acquired by it.

The first question to ask is whether the plan makes sense. What do you hope to accomplish with this move, and will your potential partnership help you reach that goal? If it won’t, there’s no need to proceed.

You also need to look beyond the obvious. For example, you can’t rely on your gut instinct to tell you if the manufacturer’s customers are poised to shift their supply base out of the country. You need to study a potential merger partner’s customer base early to learn why customers do business with the company and whether changes are in the offing. It’s important to look at the supply chain with an equally critical eye.

Next, examine how productivity and profitability will improve after the transaction. Does the target company use lean manufacturing processes? How efficient is its work flow? Does it generate significant scrap material? What are its inventory levels? In other words, are there operational areas in which you can make a difference?

Unwelcome answers to these and other operational efficiency questions may not be deal-breakers, but you need them to conduct a realistic assessment. Don’t forget to consider the costs you’ll incur in implementing needed improvements.

Be tech savvy

In today’s high-tech manufacturing environment, you can’t afford to overlook information and manufacturing technology. Integrating two IT systems can be costly, frustrating and slow. Know in advance whether your system is compatible with the other company’s and, if not, determine how much a solution will cost.

The same concerns surround manufacturing technology, if you’ll be sharing or moving it. If you’ll need a more specialized technician to keep a certain machining system running, for example, you want to know that in advance.

Communicate employees’ future roles

The success of a merger or acquisition rests heavily on employees’ shoulders, and you’ll need to communicate their future roles early and often. This is particularly important if certain executives or managers are essential to continued operations.

Don’t risk losing key employees through perceived indifference. Open and maintain lines of communication from the due diligence process to postintegration operations.

Strategy pays

Whether you’re the buyer or the seller of a manufacturing company, think of due diligence as a protective business strategy. The right up-front work can make or break a merger or acquisition. But that’s exactly why you do it.

The eyes have it

When you’re in the middle of performing due diligence for a merger or acquisition, it may be tempting to not leave your office, solely relying on videoconferences and e-mail. Modern technology can make due diligence much more efficient, but it won’t give you the full story on how a company operates — even with video.

For some assessments, you need to schedule an onsite visit. Before closing a merger or acquisition, walk through the target company’s plant and keep an eye on operations during your visit. Look for signs of stale inventory, workers missing required safety gear, and other signals that quality and efficiency may be lacking. Talk to plant supervisors and shop employees to get a sense of whether they’re committed to doing a good job, or just their job.

When you’re through, you’ll have a better idea of what improvements may be needed and what cost-saving opportunities are available. You may also come away with a sense of whether employees will welcome the change in ownership or resist it.

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