What Are We Really Buying Here?

by | Jan 12, 2021

A while back, a private equity friend told me:

“Embarrassingly… for us, organizational due diligence has been a cursory, “check the box” exercise. But missing things—talent gaps, overstatement of opportunity, key investments we don’t realize we’ll need to make—has really come back to bite us.”

Sound familiar?

He went on to tell me that this cursory, check-the-box organizational due diligence has often left them often wondering…

“What are we really buying here?”

Ever found yourself wondering this as you nervously stroked a big investment check?

I sure have.

Early in my time in M&A, our firm bought a services business that looked great on paper. Profitable. Growing. In a good market with what seemed to be tons of headroom for growth.

Check. Check. And check. ✔️✔️✔️

So, we quickly got comfortable with the deal. We did the confirmatory market, financial, and legal due diligence. We held the onsite diligence meeting, where we were treated to some locally-baked bagels and greeted with warm smiles from the team. And 30 days later, the wires cleared, and we were the proud new owners.

Now, I had a sense at the time that we didn’t have a perfectly clear picture of how the business functioned, but “we’d figure things out after the wires clear,” I reasoned. As long as the business stayed on its current growth trajectory, I frankly didn’t really care how it functioned!

Problem was: once we owned the company, we quickly discovered that on the inside, the business was a mess… in ways that weren’t self-evident until you peeled back the onion a layer or two further than we did.

☒ The owner was a tyrant, and created a fear-based culture that caused people to stay in their lane, avoid taking risks, and withold their independent thinking. There was infighting. And several valuable people were on the verge of leaving because they’d had it.

☒ He had grossly underinvested in technology, which resulted in tons of inefficiencies and lots of team frustration… and presented some real challenges to scaling and profitable growth.

☒ The managers were individual contributors with a title. They knew how to push the buttons and turn the dials in the business, but not how to lead. And as a result, they were getting considerably less out of their people (the most critical resource in a service business) than they could.

☒ There were several major capability and talent gaps in the business that needed to be shored up if we wanted to continue to grow, creating a lot more cost than we had originally budgeted for.

Suffice it to say, the cost & consequences of our oversight were significant:

We had to invest more than we expected into technology & personnel, which weighed on EBITDA. Growth slowed as we shored up the issue areas and got our house in order. The combined effect: returns suffered.

Ugh. It felt a bit like being lured into your local McDonalds by the billboard ad showing the seemingly juicy, savory, mouth-watering McRib sandwich… only to find in your bag a few pieces of soggy bread with a slab of overcooked mystery meat in the middle.

What I Thought I Bought

It can be easy for investors to get tripped-up here when:

(a) The “deal closing fever” causes them to give short shrift to all-important organizational due diligence, and/or…

(b) The people leading the due diligence aren’t operational; and consequently, don’t have as much pattern recognition when it comes to what’s required—organizationally, operationally, and culturally—for the target company to actually deliver on the growth thesis

Experiencing this myself, and hearing my buddy (and others like him) share their own war stories about the cost of getting organizational due diligence wrong is one of the reasons I left private equity to start Accelera Partners.

To help investors go into an investment with a crystal clear picture of what they’re actually buying, so as to avoid wasting money, overpaying, losing precious time, and jeopardizing returns.

And the heart of the matter is this question:

How well-positioned is the business we are buying to deliver on our investment thesis?

Answering this question clearly and confidently has significant bearing on valuation, terms, and expected returns.

To slice this question more finely so that you have some doors to go look behind, I think about this question along 4 interrelated dimensions:

4 Areas of Focus for Operational Due Diligence

 

I’ve created an Org Assessment solution that help investors develop a crystal clear picture of the organizational health of the target company, so that they can:

✅  Make better investment & valuation decisions

✅  Understand critical organizational, talent cultural, and operational risks & opportunities more clearly 

✅  Make value creation happen faster

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