Getting the most value out of M&As requires proper upfront legwork.
In the business press, discussions of mergers and acquisitions (M&As) invariably include percentages of deals that did not create their expected value. Failure numbers, ranging from 60–80%, are surprisingly high. Many companies seem to pursue deals without a clear picture of their potential risks. A due-diligence process that’s too high-level or superficial is often to blame.
For example, when a life-science company considers a merger or acquisition, the due-diligence team typically looks for 483s, Warning Letters, notified-body findings, and product recalls to find any signs of potential problems with FDA. But when a deal does not deliver value, the real causes are often strategic, cultural, or technical.
Strategy: testing the business case
Due diligence is not the same as a conducting a quality assurance compliance audit. But in the life-science industry, it’s easy to confuse the two. The executives or the private-equity firm structuring the deal do not necessarily understand the companies’ operations or FDA sanctions. At the same time, if a CEO or CFO is enamored with M&As as a perceived means to expand into a new business or enter a new market, the due-diligence team typically lacks the business expertise to ask the right questions or the clout to raise objections.
For example, Company A might want to buy Company B because of its superior sales force. Company A’s marketing department contends that sales would double; the finance department believes that redundancy would allow Company A to reduce payroll by 10%. Both predictions are correct, but no one calculates the extra manufacturing capacity needed to produce a larger portfolio and volume of products. The expected value of the deal could be canceled out by unanticipated costs in another part of the organization.
The fundamental questions asked during due diligence should go beyond FDA compliance and tackle the business reasons for closing the deal. This approach requires having the right people (not necessarily those who happen to be available) on the due-diligence team. Technical executives might be asked about open citations, but they’re rarely consulted about the likely costs of integrating factories, supply chains, or distribution centers—or whether these integrations can be done at all. But if integration costs more or takes longer than expected, customer relationships and product quality can suffer.
Culture: gauging compatibility
Often in a merger or acquisition, the personalities of the two companies are not considered relevant. But stress and tensions can build when the cultures of two organizations are incompatible. The possible triggers of a poor “culture fit” are limitless: management style, risk tolerance, flexibility, talent, technology, and geography, to name a few. Some life-science companies are risk-takers; others are conservative. Some are entrepreneurial; others are hierarchical. Some are obsessed with “zero incidents” quality; others have a “find a problem, fix a problem” management style. If the two cultures can’t be blended, the cost of a significant restructuring (including recruiting and hiring new executives) needs to be included in the M&A price tag.
Post-M&A integration is often the cause of extra, unplanned costs. For instance, a seller often ends up supporting sold-off processes or IT systems long after the deal is done. When this happens, the buyer can end up with a poorly managed function, and the seller can end up with disgruntled clients and extended costs. The deal’s stakeholders, each with different goals and agendas, need to talk to each other. External stakeholders can also be drawn into the due-diligence process to reduce such risks.
Transition services agreements (TSAs) should be drawn up carefully to protect buyers and sellers from value destruction. For the buyer, a TSA might specify that the seller’s employees will be available to talk to regulatory authorities during the integration time period. For the seller, the TSA might detail roles and responsibilities for the sold business or division. A key executive or consultant should ensure that TSAs are followed and that the buyer takes over on schedule.
Due-diligence best practices
Any life-science company considering a merger or acquisition should consider the following five steps to ensure that its due-diligence process helps manage business risks and prevent value destruction.
Put the right people on the team. A life-sciences company typically has multiple locations, some in other countries, as well as complex supply-and-distribution operations. The time available to draw up an offer can be as short as two to three weeks. The due-diligence team therefore should be structured to quickly obtain real-world answers to fundamental questions. This means including experts who can look at limited data and draw reasonable conclusions about areas such as: manufacturing, product portfolios, supplier relationships, IT capabilities, R&D and engineering, marketing and sales, and environmental compliance. A quality assurance specialist cannot cover all this ground alone. Perhaps most important, the team needs a senior executive who has the power to champion the right answer for the deal, even when that answer is “no.”
Consider the following example. A US company wanting to acquire a high-growth product line made a play for a successful company headquartered in Australia. The rewards matched the company’s objectives: revenue from sales outside the US would jump from 15 to 40%. However, the risks would be just as great: registrations and patents would require global management, and the success of the venture depended on keeping the seller’s key people and infrastructure. The-due-diligence team included the COO as well as senior people from manufacturing, finance, legal, quality assurance, business development, and R&D, and an independent consultant to question assumptions. In addition to working with a virtual data room, the team spent two days interviewing seven of the seller’s top executives and one day touring the main production facility. The team included a senior executive who would be in charge of the postmerger integration crucial to future revenue and earnings. Because the due-diligence team had the right people, the process contributed significantly to the immediate and long-term success of the acquisition.
Ask the right questions. In many ways, due diligence is a detective’s game: the analysts need to look at clues (often from only partial data) and solve the mystery by defining the business case for the merger or acquisition, identifying the ways each facility or function would contribute to (or detract from) the realization of the business benefits, and pinpointing risks to processes, functions, or the enterprise. Even companies that do a lot of deals are wise to treat each one as a new and unique experience.
Find weak spots and define fixes. The due-diligence team needs to address areas of risk, such as the costs and efforts required to harmonize operations, the timetable for fixing problems, and the investment needed for postmerger integration. For example, upgrading an acquired company’s enterprise resource planning system would be expensive and resource-consuming; its costs should be acknowledged.
Use facts to negotiate. The financial decision makers want to know of any issue large enough to stop the deal. But even problems that are not dealbreakers could be used in negotiations. The due-diligence team needs to be prepared to talk to C-suite executives, bond-rating agencies, investment bankers, and the sellers about issues, potential solutions, a course of action and as its timing and estimated price tag.
Bring in the regulators early. The postdeal organization should inform FDA or other appropriate regulators of plans to fix recognized problems. Regulators know that M&As can create confusion and inconsistencies, and they look for them during inspections. Even if there are no problems, it is a good idea for the buyer to connect with regulators to help ensure a smooth transition. Due diligence is a strategy for risk management and return on investment. When done right, it helps ensure value creation in a merger or acquisition.
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