Thinking beyond due diligence when making acquisitions

In mergers and acquisitions (M&A), the due diligence process takes center stage. This is where you review the target company’s historical performance, financial projections, marketing strategy and a host of other factors. The challenge, however, is that focusing on checklists, financial statements and other specific company details can produce a by-the-numbers, mechanistic approach to M&A, one that overshadows another important process — namely, strategic decision-making.

In fact, strategic decision-making in M&A is just as important as due diligence, but it is often overlooked, says James Schrager, clinical professor of Entrepreneurship and Strategic Management at the University of Chicago Booth School of Business. Over the course of his career managing corporate turnarounds, conducting research, advising CEOs and sitting in corporate boardrooms, Schrager has identified what he describes as three of the most overlooked strategies for sound decision-making in M&A.

1. Decide not to decide

One of the worst things that can happen in any acquisition is that emotions cloud the judgment of a company’s management team when evaluating a target company. For example, there may be instances when a CEO is so optimistic about a potential acquisition that they decide to pursue the deal without ever visiting the company or doing the necessary groundwork. Instead, the decision is made based on superficial factors, from the potential for top-line revenue growth to the prospect of expanding the company’s footprint.

“This is one of the most fatal mistakes I’ve seen,” says Schrager. “Once a person commits emotionally and intellectually to a particular decision, it becomes very hard to reverse course.”

To prevent this from creeping into the decision-making process, it’s important that CEOs and management teams decide not to make a decision about a potential transaction until they get all of the necessary information. It may be prudent to suspend belief and consistently take the default position that you don’t have enough information — that is, until you and your management team have come to a consensus.

2. Be quiet and listen

Company visits can go a long way in providing insights into a company’s culture, employee satisfaction, the competency of the management team and other intangibles that may not be easy to quantify on a spreadsheet.

And while it may be tempting to engage in a spirited exchange of ideas during your visits, you may be better served by being slow to talk and quick to listen. “Whenever you visit a target company to assess its operations, be friendly, nice and smart. But most importantly, be quiet,” says Schrager. “You’re not there for the sales pitch. You’re there to figure out what they haven’t told you.”

By his estimation, it can take a great deal of discipline to check your enthusiasm at the door. Indeed, this is a time when CEOs and management teams want to hold their cards close. It’s one thing to be enthusiastic about a target company behind closed doors, but whenever visiting a company that you’re considering for an acquisition, listen and determine whether there are any anomalies that contradict the company’s sales pitch.

3. Ask yourself, “What is my strategy with this acquisition?”

CEOs have busy lives and make countless important decisions every day. But when do they have time to think about the implications of their decisions? This kind of mental exercise can feel like a luxury when there’s so much competing for our attention. But when there’s a potential investment at stake and considerable sums of money on the table, CEOs need to take the time to ask themselves, “What is my strategy with this acquisition, and does it align with our short- and long-term growth plans?”

Let’s consider a hypothetical company for one moment. Company A is involved in specialty products and is considering acquiring Company B, which produces generic products. Company B is selling for a price way below book value and is not profitable. But this is by no means a deal breaker.

As it turns out, a problem arises because the products produced by Company B are highly commoditized, with customers regularly negotiating prices down. Meanwhile, Company A operates in a specialized industry — one in which the product they sell is differentiated.

Before making the acquisition, the CEO of Company A didn’t fully consider their strategy when acquiring Company B. Now the CEO has an unprofitable business that operates in unfamiliar territory.

This misstep could have been avoided if the CEO and management team honestly asked themselves where this acquisition fits within the broader growth strategy. If they had, they may have avoided this commoditized business and focused their energies instead on a target company better aligned with their own expertise.

Expanding your options

Growing a business organically can be difficult, and M&A can be a powerful strategy for companies that want to maintain their competitive edge. Still, there are no shortcuts. In fact, there are countless examples of how making an acquisition has tested the mettle of even the best management teams.

This is why it’s so critical that CEOs and their management teams look beyond their due diligence checklists and avoid jumping to conclusions too quickly. Look and listen for anomalies in a target company’s narrative when considering an acquisition, and constantly reference your strategic goals during your due diligence process. You may find yourself with a much wider range of options for growing your business.