Updated: Nov 30, 2022
Paul Feeney, CEO of Quilter, courageously admitted that the firm failed in its due diligence when acquiring Lighthouse Group. Although few of Mr Feeney’s peers have been as explicit about their own experiences, a chasm between due diligence before purchase and regulatory reality afterwards is virtually guaranteed by the standard approach to acquisitions.
Due diligence is designed, above all, to feed into negotiations around a deal. The process is run by transaction specialists, usually lawyers, and feeds into price and contract negotiations. The specialists who run the due diligence process aren’t the same people as those who have to run the business later. That creates an immediate disconnect between the transaction and future realities.
This disconnect is widened by the fact that a legal-driven approach tends to focus on adherence to the current rules rather than the risk (or even likelihood) of retrospective regulatory action. Time and again we have seen firms relying on lawyers confirming adherence to the rules in situations where the stench of poor practice, a clear portent of future regulatory intervention, would be obvious to any compliance practitioner.
Finally, the primary driver of a deal is always opportunity: whether it is an opportunity to build turnover and revenues, gain strategic advantage, or share costs. Risks come as an afterthought, and if they are not quantified properly they remain intangible and difficult to assimilate into decision-making.
What makes the situation worse is that regulators commonly hold acquirers more strongly to account for the sins of an acquired company. That’s practical and understandable: why pursue a small company to its demise, when you can wait for a larger firm with more resources and deeper pockets to acquire it?
Lawyers and bankers are incentivised to get the deal done rather than identifying and quantifying the risks that might prevent that from happening. Not unreasonably, they point to the management team as being primarily responsible for the risks they are accepting. But, in practice, the people best qualified to assess risk are up to their necks in business-as-usual while the top team are engrossed in the deal.
The good news is that it doesn’t take a lot of extra effort or cost to quantify acquisition risks properly and avoid expensive surprises. To establish the cost of a risk, you need to work out how it would be dealt with – in other words, to plan. So the work already being done through the due diligence process needs to be completed with a mini integration plan by operational and compliance professionals. Those same experienced people will also be able to sniff out weaknesses and gaps in data that could be glossed over by the classic data room approach.
The true cost of the regulatory risks can then be factored into price and contract negotiations, raising the confidence of the acquirer to the benefit of both parties. And, once the deal is complete, the same people who built the plan can start implementation immediately and seamlessly: they don’t need to track back over several months to scrutinise due diligence data couched in legal language that may be incomplete or unhelpful.
The same applies to incorporating the administration of the acquired company: building a plan identifies risks and their costs, and people and systems can be transferred immediately without the damage and cost created during the uncertainty of an interregnum.
Similar benefits are available to an enlightened company that wants to be acquired. To the extent that it quantifies its risks by planning for how to manage them, and making the viability of those plans clear to the acquirer, it can make itself a more attractive purchase.
This does require effort and costs, but these are modest compared to the costs already being incurred by acquisition, and the potential for disaster if things go wrong. Management over-stretch can be eased by engaging a small number of external professionals with real experience, either at the front end or by backfilling business-as-usual.
The philosopher and social theorist John Ruskin said it better than we ever could:
“It's unwise to pay too much, but it's worse to pay too little. When you pay too much, you lose a little money – that is all. When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing the thing it was bought to do. The common law of business balance prohibits paying a little and getting a lot – it can't be done.”
A lot of money is usually spent on due diligence. If it dies as soon as the deal is struck, a lot is potentially wasted. A modest investment in risk assessment and planning brings the same data to life and can significantly reduce subsequent costs and nasty surprises.