“Diligence is the mother of good fortune.” – Miguel de Cervantes
“Ignorance never settles a question.” – Benjamin Disraeli
Based on comments that I received on my May 29th post, I think further light could be shed on my bias toward an elevation of skills as one moves into the leveraged lending arena. Not to say these same principles would not apply to balance-sheet lending, I just don’t see it often followed…
Leveraged transactions, and lending therein, require more robust effort across the deal spectrum. Specifically in the area of due diligence, there has long been advice to lift the game from overly relying on templates and due diligence lists:
To think like an investor is to lay the foundation for M&A success. Its relevance to due diligence is to inspire an attention not only to risks, but also to returns, especially their drivers, uncertainties, and constraints. To focus narrowly on risks is to adopt a compliance mentality that easily reduces to data-fetching and checking lists. On the other hand, an investor mentality goes farther: it seeks to gauge the risk exposure and the investment attractiveness of the target. To think like an investor during a due diligence review is to assess critically both risks and returns; to understand opportunities as well as threats (strengths as well as weaknesses); lay the foundation for sound bargaining and integration; and generally help senior executives answer the question, “Does this target present an attractive risk-return trade-off?” The first principle of due diligence work should be to avoid a compliance mentality and adopt an investor mentality1.
So this begs the question, does the due diligence team on the deal have the requisite skill set to adapt to this paradigm?
A recent study2 noted that the complexity of M&A market illustrates that “today’s deal makers need to ask themselves the following questions:
- When was the last time you audited your company’s approach to due diligence?
- Are you certain that your due diligence is delivering all it should be in today’s complicated M&A environment?
- Are you focused more on the latest checklist of legal and accounting due diligence than the prioritization of critical items?
- How do you differentiate the critical items to prioritize when you don’t know what the issues are going into the transaction?
As in Bruner’s note earlier in this piece, this latter study breaks down due diligence into a) risk mitigation due diligence and b) value creation due diligence. The study points to Robert Filek, global leader of the Transaction Advisory Services group at FTI Consulting, “There is a connotation of risk and negativity associated with the term [due diligence]. The truth is that in today’s market, due diligence has to be equally balanced with areas of opportunity as much as it is around risks and concerns. One of the biggest mistakes you can make around due diligence is not having the proper balance of opportunity in the process.”
We will have more to say on the critical process of due diligence, but in the meantime take comfort that many in the industry share the view that there is considerably more to M&A due diligence than cookie-cutter approaches, lists, and check boxes.
1Robert F. Bruner, “Applied Mergers and Acquisitions”, (New Jersey: John Wiley & Sons, 2004) 209.
2Merril DataSite and the M&A Advisor, “Guide Series: Mitigating Risk and Creating Value: A Focused Approach to Due Diligence”, 2012.