The Sum Of Parts: Due Diligence Done Good & Bad

The Sum Of Parts: Due Diligence Done Good & Bad

“The Sum of its Parts” is a well-known idiom that means the whole is equal to the combination of its individual parts. This phrase is commonly used to emphasize that each component of a system or group is important and contributes to the overall functioning or success of the entity. It can also be used to describe how complex systems can be broken down into simpler parts for analysis to aid decision-making. In contrast, “Synergy” is often referred to as “the whole is greater than the sum of its parts,” similar to how a puzzle forms a complete picture. There is thus a pivotal process of interplay between the Parts and the Picture when considering Due Diligence.

This relationship between the Parts and the Picture should always be the centred approach when conducting a proper Due Diligence. When considering an investment or acquisition, conducting due diligence is a critical step to ensure that the whole of the investment is sound, for as far as possible to convincingly determine in all measurable aspects, and that potential risks are identified and mitigated, and lastly opportunity was recognised and quantified.

The error that is made time and time again is the general “copy-paste-edit” and prevalent current market approach of conducting a due diligence.

The Diminished Recipe Looks As Follows:

• 80% Financial Due Diligence.
• 20% “Everything-Else” Diligence.
• High focus by financial professionals.
• Low-Moderate focus by other expertise.
• Outside, Top to Bottom methodology.
• Historic emphasis.
• Orientated to more Risks & less Opportunities.

The spirit of this approach is not necessarily and wholly wrong nor giving zero value proposition, as the argument is line with the financial performance as the ultimate indicator and build-up of everything else that have occurred and are reasonably assumed to continue under some set of conditions. But, the most often repeated fallacy of this argument and approach is that the 20% of Everything-Else was not nearly analysed and advised on enough, together with a balanced financial view, to form a more complete picture of future performance, risk and opportunity expectations.

It is too often the case that after the investment was done the gremlins starts creeping out the 20% holes… This leaves the new management of the business baffled and investors nervous at best or

gives way to legal and other contingencies at worst. Rarely does anyone look or question the diligence of the due diligence. As the saying goes: “the only constant is change” and as such that 20% is going to determine the 80% of your business performance in the future, so it’s better to pay more attention to that in the Due Diligence Process.

The essence of a proper Business and Investment Due Diligence revolves around forming a comprehensive picture of all the parts, in equal measure, individually and collectively, internally and externally, which includes:

• Financial
• Operational
• Legal
• Commercial
• Technological

A Successful Due Diligence Recipe Looks As Follow

• Balanced & objective approach in all parts of the process.
• High focus and contribution by all professionals (finance, management, legal, engineering, IT)
• Outside-In, Bottom-Up methodology.
• Historic input >> Current picture >> Future Expectations Emphasis.
• Oriented to Risks & Opportunities as inputs to Performance

In Broad Terms A Balanced & Holistic Due Diligence Covers These 5 Main Pillars:

Financial

Financial due diligence involves reviewing the financial health of a company, including its financial statements, tax returns, cash flow statements, and other financial documents. The goal is to verify the accuracy of the financial information provided by the company and identify any potential financial risks. This type of due diligence also includes an analysis of the company’s historical financial performance, financial projections, and key financial ratios to assess the company’s financial health.

Operational

Operational due diligence involves evaluating a company’s operational processes, systems, and procedures. The aim is to identify potential operational risks that could impact the success of the investment or acquisition. This type of due diligence includes a review of the company’s management structure, human resources, manufacturing processes, health and safety, supply chain management, property, plant and equipment, and other operational processes. The aim is to evaluate the efficiency of the company’s operations, identify areas for improvement, and assess the company’s ability to meet its business objectives.

Legal

Legal due diligence involves evaluating a company’s legal standing, including its contracts, agreements, and legal liabilities. The goal is to identify any legal risks that could impact the investment or acquisition. This type of due diligence includes a review of the company’s legal documents, such as contracts, policies, records, leases, licenses, and regulatory filings. The aim is to identify any legal liabilities, such as pending litigation or regulatory compliance issues, that could impact the investment or acquisition.

Commercial

Commercial due diligence involves evaluating a company’s market position, competitive landscape, projects, and growth potential. The goal is to assess the company’s commercial viability and identify any risks that could impact the investment or acquisition. This type of due diligence includes a review of the company’s products and services, market share, customer base, and marketing strategy. The aim is to evaluate the company’s competitive position, assess its growth potential, and identify any potential risks in the market.

Technological

Technological due diligence involves evaluating a company’s technology infrastructure, systems, and processes. The aim is to identify potential risks and opportunities associated with the company’s technology assets and skills. This type of due diligence includes a review of the company’s IT systems, software applications, hardware, data security measures, and technology-related contracts. The goal is to evaluate the company’s technology infrastructure, identify any potential security vulnerabilities, and assess the potential for technology-driven growth.

In conclusion, conducting due diligence is a critical step when considering an investment or acquisition. Each type of due diligence focuses on different parts and aspects of the company and is necessary to provide a comprehensive assessment and picture of the investment opportunity. It is important to engage experts in each field to conduct a thorough due diligence process and provide recommendations to mitigate potential risks and develop opportunities.

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