Why Cultural Due Diligence in M&A transactions is important?

Cultural Due Diligence is important in M&A

Most acquirers are generally bad at Cultural Due Diligence. Cultural alignment between the acquirer and target company is very important and determines the overall success of the M&A deal.Recent studies analyzing M&A transactions over the past 5 years have consistently identified two key findings.First finding is very obvious which tells that Culture is crucial success factor for M&A transactions.Another major finding tells that most acquirers are generally bad at Cultural Due Diligence.
As there is a link between culture and deal success or failure, it is very important that acquirers conduct a meaningful pre-cultural due diligence to identify cultural alignment between the acquirer and target, any cultural issues that might happen after the deal closes and steps to be taken by the acquirer to mitigate these risks post closing.Generally acquirer appoints independent consultants to conduct Financial, Tax and Legal Due Diligence to carry out Quality of Earnings study, identify legal risks and tax liabilities of the target business.In case of cultural due diligence, it is conducted mostly by the acquirer’s organization. Most acquirers do not even give an high importance on culture as they give to Financials and Technology during the Due Diligence.
Companies that acquire frequently or follow a programmatic M&A approach discover the extreme importance of Pre-deal cultural Due Diligence. These acquirers think that M&A should be considered as an end to end business process.Each deal goes through a full lifecycle of phases.In each phase, there is a corresponding set of integration related actions that should be achieved in order to realize value.
An approach to Cultural Due Diligence should never be seen as a finite one step exercise. At the initial stages of M&A lifecycle, the data points on the target company is limited.Hence it is difficult to arrive at any decision on the target company’s culture by conducting a formal cultural assessment. Once the definitive agreement is signed between the target and acquirer, the acquirer can appoint a clean team to do a formal cultural assessment of the target company.Due to the regulatory and legal challenges, the acquirer’s team cannot assess the culture of the target company and need to wait till the deal is closed.
Assessing a target company’s culture is a comprehensive process.Multiple rounds of discussions and meetings need to happen with the target company’s employees to confidently understand the target company’s true culture, risks and implications for integration.Cultural due diligence generally happens at a very informal basis during the early stage of the M&A deal and then become more formalized as we move towards the closing of the deal.

Cultural due diligence in Initial Target Screening Phase

• The acquirer needs to establish a cultural screening criteria for the target companies.The deal team can get an initial sense on the target company’s culture by looking at websites like glassdoor and Indeed.If the ratings for these companies are very poor, then it is advisable that acquirers skip through such transactions in order to avoid spending time and efforts.
• The screening criteria should basically be a shortlist of important greenlight and redlight cultural indicators.This will help the deal team to eliminate transactions that do not meet the acceptable criteria.
• Another approach would be to conduct discussions with target company’s former employees, customers and vendors to get strategic insights about its culture.

Due Diligence Stage

• All M&A transactions start their cultural due diligence after having launched the core strategic, financial, legal due diligence.The cultural due diligence will start only when the analysis of the prior due diligence indicate that there are no show stopper issues.It is advisable for the acquirer to create cultural related due diligence checklist that addresses questions around target employees opinion data, their employment value proposition and key work life balance.The important cultural data can only be obtained by direct observation, dialogue with key executives of the target organization and validating this with key employees of the target company as they get brought into the deal.
• The acquirer’s team should conduct structured interviews with key executives of the target organization.In some deals, limited culture surveys can be taken with the key employees of the target company who are aware of the deal and under NDA.
• In this stage, most target companies will be hesitant to share sensitive data as this might affect the transaction.

Cultural due diligence in integration planning and execution stage

• Once the deal is announced publicly and the pre-close integration planning process is underway, most target companies will permit broader access to integration team members and function leads to conduct formal cultural assessments.
• The integration team need to work closely with the target company’s executives to define what should be the ideal culture of the combined organization in order to maximize the deal value.It is far more important to actively engage with the key executives of the target company in defining the high performance cultural attributes of the combined company.Once the discussions are complete, the integration team should align the combined business around these objectives.

Conclusion

Almost every M&A study comes up with two key findings.They are:

1. Culture matters in M&A
2. Acquirers are generally bad at cultural due diligence

This explains why Pre-deal cultural due diligence is important in M&A transactions to maximize deal success.