1 DECEMBER DUE DILIGENCE A SPECIAL REPORT ABOUT AVOIDING POTENTIAL PITFALLS IN MERGERS AND ACQUISITIONS 2006 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated. We pride ourselves on our firms Private Equity credentials KPMG's Private Equity practice has advised on many of Europe s largest transactions. In 2005 KPMG firms worked on 8 out of the top 20 European buyouts (by size) and our excellent track record continues in We believe we have the best individuals in Europe, the U.S. and worldwide and will work together to get you the answers you need to help you make the best decisions for your firm. For more information please contact: Rustom Kharegat (KPMG in the U.K.) +44 (0) John Evans (KPMG in Germany) +49 (0) Don Spitzer (KPMG in the U.S.) +1 (212) AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED WITHIN THE TIMES
2 2 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES Elements of good due diligence The stakes at risk in mergers and acquisitions are high, ranging from mere deal failure to bankruptcy. What can companies do to make their deal a success? One of the very few things known to make a deal a success is good due diligence. Traditional due diligence assesses risks, threats and weaknesses in a potential target or partner. But identifying warning signs such as unusual ratios, resignation of auditors, a change in accounting methods, high turnover and liabilities is not enough. You should always have well-defined deal breakers, and due diligence will help you stick to them Entrepreneurial perspective Good due diligence also provides the entrepreneurial perspective, a reality check and a forward glance. Don t get lost in the nitty-gritty of a traditional due diligence legal, accounting, human resources, information technology, environment, intellectual assets, risk management, etc. You need to put all this together to get the big picture, and to see the scale of the opportunity and the scale of the potential return. Reality check You should also use due diligence to do a reality check. Is the target what you think it is? Is it what you actually want? Does the target really meet your requirements from a strategic and operational perspective? You should always have well-defined deal breakers, and due diligence will help you stick to them. CONTENTS Give investments the diligence they re due 3 Upside story 4 People power 4 Tips from a top deal-maker 5 Running the numbers 5 Ask the panel of experts 6 Operating ahead of the game 7 Technical expertise 7 Legal due diligence 8 Strategic intelligence 9 SuperReturn celebrates anniversary 10 No nasty surprises 11 Dr Christopher Kummer Look to the future During due diligence, the acquirer should look to the future. Most information will be historic. How things will evolve is the more important question and is difficult to answer. Due diligence is also a fundamental input in planning the integration phase. Dr. Christopher Kummer is Jr., Professor at Webster University, Director of the Institute of Mergers, Acquisitions and Alliances, both in Vienna/Austria, and Visiting Scholar at Kingston University, London. DUE DILIGENCE, A TITLE FROM MEDIAPLANET. Project Manager Nigel Stewart, Production Editor Ulrika Fallenius, Editor Margaret Dell, Design/Production Jez MacBean, Print News International For more information about supplements in the daily press, please contact Carl-Philip Thunström For more topics in-depth, please visit Mediaplanet is the leading European media company specialised in producing, distributing and developing special interest information for print, online and broadcasting in nine countries. Mediaplanet in association with Mergermarket is an independent M&A proprietary intelligence tool. For more information visit us at
3 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES 3 Give investments the diligence they re due The rise of private equity has been one of the most marked phenomena in the financial markets over the past ten years. And, alongside this rise has been an explosion in the number of specialist firms serving this growing market of buyers and sellers. As the complexity of deals has risen, so too has the range of services that have grown up around the industry. In particular, the number of due diligence firms or specialist due diligence teams in professional firms supporting private equity has grown, according to Peter Linthwaite, chief executive of the BVCA (British Venture Capital Association). The BVCA is the industry body representing virtually all UK based private equity firms. The association promotes best practice in private equity investment. Mr Linthwaite says, When you re looking at a private equity deal, you re looking at a medium term investment, which is relatively illiquid. The whole relationship between the private equity house and the management is a medium-term partnership to achieve specific goals. Therefore, in making the investment, it s important that all aspects of the business are analysed and considered. Specialisation The due diligence process involves many different aspects of research, according to Mr Linthwaite, and may, therefore, require different teams or even different firms to conduct it. Operational due diligence will look at matters like intellectual property rights, e.g. patents, trademarks and copyright and the effectiveness of core technologies. Commercial due diligence will examine the dynamics of the market: is it growing or not? Is it fragmented? Is it likely to consolidate? Is it open to overseas competition? Financial due diligence turns the books inside out, looking at capital structure, the efficiency of the tax structure and at how conservative or aggressive the accounting policies have been, together with a review of the company s future projections. There are also new areas of due diligence, Mr Linthwaite says. Within the financial due diligence portfolio, pensions have become a potential deal-breaker. Therefore, it is essential that any would-be acquirer have a full actuarial valuation of assets and liabilities. Many companies will be alive to environmental risks. The decision by the state of California to sue the world s biggest carmakers because of their contribution to climate change points up the potential dangers of environmental liabilities emerging unexpectedly. Personnel file Private equity houses will also want to look at the backgrounds and character of management in the acquiree company. This has always been considered good practice, but is becoming an essential. Britain s anti-money laundering legislation makes it essential for investors to know who as well as what they are buying into. When doing business in an international company, investors need to understand the ethics and the efficacy of the business practice in other countries. America s Foreign Corrupt Practices Act places a duty of care upon American companies when doing business abroad. Often, having professional investigators look into the background of individuals with which a company is doing business can act as a defence against accusations of negligence. Mr Linthwaite says, It s not just about the law. Reputational risk is very important. Investors need to understand exactly how the business is being conducted, who the sellers are, who all the directors are. It s sensible business practice. Potential pitfalls Of course, all of these potential pitfalls need to be looked at in the context of the attractiveness of the investment opportunity and the effect they may have on the achievement of the business plan put forward by management. Private equity houses which tend to be lean in personnel are unlikely to have in house expertise in all of these fields, according to Mr Linthwaite. Therefore, they need to reach out to the huge network of new due diligence specialists and to ask these different specialists to do research and to put their findings in the context of the wider market. In the past, there were only a handful of firms dealing with private equity whereas today Mr Linthwaite reckons that there are some 12,000 full-time employees engaged in supporting the private equity industry from around 1,000 firms. OC&C STRATEGY CONSULTANTS Commercial and Strategic Advisors Advisors on 50bn in transactions in 2006 Areas of focus Consumer Services TMT +44 (0) Brussels Düsseldorf Hamburg London Mumbai New York Paris Rotterdam San Francisco
4 4 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES Upside story Commercial due diligence is now as much about spotting the upside opportunity as managing the downside risk, says David Krucik Highly competitive auctions, the ever-increasing scope of deals and the sheer scale of available funds are making private equity more challenging than ever. Players must work harder to find the upside that makes a deal worth doing. This means that the role for strategic commercial advisers skilled enough to spot unidentified profit potential is becoming increasingly important. The commercial advice we give comes under the heading due diligence and it remains our task to provide the comfort that debt providers require. But our role is evolving into something more creative and more fundamental to fund performance; discovering commercial opportunity. We are there to spot the upsides as well as the downsides. Originally, commercial advisors had a limited role in selected transactions, making market reports on potential acquisitions. Then we started to apply the skills we deploy in our corporate work to assess companies business plans and their ability to achieve them. A better business plan Increasingly, we ask not only whether the business plan is achievable given market conditions, but whether there isn t a better business plan. We can offer insight beyond the capability of other financial advisers, because we bring sector experience and a track record in corporate strategy and its realisation. Naturally, our assessment of the environment in which the business trades and our review of the company business plan remain vital in establishing the achievability of the investment case. But that work is now becoming merely the starting point for a more demanding inquiry. Has the business identified all areas of profit? Can it work more efficiently? Are there unrealised areas of growth? Our task is not just to look at the levers that the company and potential buyers are planning to pull, but also to find, to quantify and to qualify levers no one has even thought of. Private equity buyers need to be confident that they will achieve revenues to service their debt and a business that will turn a good profit when they sell on. They make money only when they do deals, so they are keener to find reasons to do a deal than not to do a deal. Naturally, then, they benefit from having commercial advisors who can take a broad rather than a narrow view to identify the upsides of a transaction. If they don t find those upsides and someone else does, then someone else will do the deal. David Krucik is head of OC&C Strategy Consultants Private Equity practice. Buy-side and sell-side These creative principles apply whether commercial advisors are working for buyers or sellers. Sometimes, the work we do for sell-side clients in identifying bigger cash flows, new value and better ways of running the business is so compelling that they change their minds. Strategy Identifying the equity case uses all the analytical, creative and intellectual skills of strategy consulting. Many private equity houses ask us to work with the businesses they have acquired, helping to achieve the potential that we have identified. Leading firms are learning that, through effectively deploying commercial and strategic advisers, they are achieving higher win rates when buying businesses, more effective cash generation for debt repayment and greater value at exit. PEOPLE POWER BY LYNDA PURSER Most people understand due diligence as the process by which business advisers and consultants examine your organisation, its financial records and business plan. These outsiders will both focus on past performance and assess likely future success. They will make judgments about senior directors within the organisation. Hard vs soft assets And they are not wrong to do so. But, too often the emphasis is on socalled hard assets and senior management. Too little consideration is given to the workforce as a whole. What attention is paid to the professionalism of individuals across an organisation? In assessing future growth, how much attention is paid to their experience and skills development? However, it must be stressed that the measures taken should not simply be a response to regulation. Rather they should provide the critical information to run the organisation. For due diligence to work it needs to be more than a process. And with 80 per cent of a company s worth tied to the value of its employees, more practical guidance is needed to develop relevant measures, if future investment and corporate decision-making are to be better informed. Lynda Purser is Director of the Institute of Management Consultancy NEWS IN BRIEF The latest trends in M&A activity owe much to a number of factors. Despite the recent announcement from the FSA that watchdogs are to monitor the increasing record value of deals being done in the UK, the market shows no signs of slowing down. According to the experts, this year s boom not only demonstrates the stability of our economy but the strength of growing markets such as the Asian commodities market. The success of private equity houses has led to confident investors eager to join in, and coupled with the low cost of borrowing, these trends are expected to continue into 2007.
5 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES 5 TIPS FROM A TOP DEAL-MAKER SOME RECENT BDO STOY HAYWARD DUE DILIGENCE DEALS Guy Hands is one of Europe s top dealmakers. After a 12-year career at Goldman Sachs, he moved to Nomura in 1994, where he set up their Principal Finance Group. In 2002, PFG was spun out into an independent firm, Terra Firma, one of Europe s leading private equity houses. Due Diligence caught up with Guy middeal, where he took an irreverent take on how to make it in the jungle that is private equity Guy, what are your 5 top tips for success in private equity? Sell encyclopedias door to door in the winter Spend two weeks on a jury trial Get at least five years training at an investment bank such as Goldman Sachs Lose a substantial part of your own net worth more than you can afford Realize that your success is down to others and to luck and that your failures are what make you stronger What types of due diligence does Terra Firma use? We do two types of due diligence at Terra Firma. First, due diligence that we pay for externally and which is generally worthless but the banks insist on it. Second, our own where people are investing their own money, which costs nothing but adds critical value. 570m acquisition of 290 managed pubs from Punch Taverns Plc by GI partners 61m acquisition of Proc Cyber Services (UK) Limited by DataCash Group Plc 30m acquisition of Microlease Plc by Lloyds Development Capital 20m acquisition of Total Home Entertainment by Entertainment UK, a subsidiary of Woolworths Group Plc 22m acquisition of Pan European Restaurants by Barclays Private Equity 20m acquisition of Performance Products Ltd by Cobra Electronics Corp 86m acquisition of Whitworths by European Capital 30m acquisition of Lee Cooper by Sun Capital Partners, Emerisque Capital and The 180 Group 446m acquisition of Hospitality Europe BV by The Blackstone Group 325m acquisition of Initial Style Conferences by the Alternative Hotel Group Can you point to an example where due diligence has unearthed a deal-breaker (e.g. pension deficit). A listed UK company on which due diligence unearthed that the Chief Executive could spend up to six figures on entertainment without board approval. Terra Firma s proposed limit was 1,000. Running the numbers Financial due diligence has evolved to focus on the most critical issues driving deals, says BDO Stoy Hayward s Graham Elsworth Financial due diligence has always been an essential part of any merger or acquisition. However, in the past it has often been regarded as a tickbox exercise. With increasing competitiveness in the market and purchasers looking for new and different angles on a deal, financial due diligence has had to evolve. Increasingly, the exercise is focused on the issues driving the deal, with the accountants being one of a number of advisers undertaking a full range of due diligence commercial, operational, legal and environmental. The focus of financial due diligence is shifting, with priority now given to understanding how a business is performing and the extent to which operations can be improved. While clients still want assurance on the numbers, they increasingly demand opinions on the implications of the financial analysis on the proposed transaction. Advisers are also providing real-time feedback, so that clients can react to findings as the deal progresses. The deal landscape is constantly changing and recently, pensions have become one of the key issues. For example, Permira recently walked away from a bid to buy W H Smith, the newsagency chain, because it balked at plugging the hole in the pension fund. Similarly, we recently advised an American corporate seeking to acquire a British business owned by a private equity group. The seller had indicated that the company s defined benefit pension scheme was fully funded. Our actuaries took a closer look and discovered that there was a potential 15m hole a big issue in a 30m deal. The deal completed but at a substantially lower price. A phased approach Reporting accountants need to be close to their client to understand the rationale for the acquisition before attempting to get under the skin of the target. This has led to a phased approach to due diligence investigations. The first phase identifies critical issues that could derail a transaction. The second, broader, phase covers areas that are important but not necessarily key to the transaction. The focus will vary from deal to deal, according to the investment rationale. However, it will include: working capital, tax, pensions and critical balance sheet items. How well is the company managing its working capital? Could debtor days be reduced? Could creditor payments be stretched? Is the target company paying more tax than they should be? Is the financial structure as efficient as it could be? Could it bear a higher level of debt? And most importantly, what happens to the cash? Finally, there is the post-completion plan to consider. The more thorough the investigation done in the earlier phases, the smoother the post-deal integration will be. Clients are becoming more demanding and transactions more complex. As a result it is critical that their due diligence advisers have the international reach and capability to understand not only the financial, legal and business issues but the cultural challenges that can be critical to the success or failure of a potential transaction. But the whole value of the due diligence process is underpinned by the advisers opinions. Sitting on the fence is no longer an option. Graham Elsworth is a corporate finance partner at BDO Stoy Hayward
6 6 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES Ask the panel of experts Mark O Leary, Corporate finance partner, BDO Stoy Hayward What question or questions is financial due diligence trying to answer? The due diligence process enables prospective investors to ensure they make an informed investment decision. As such, there is no one size fits all - in fact it is critical that the approach and focus of financial due diligence is tailored to each situation. With this in mind, there are certain key questions that do (or should) arise in all FDD reviews: Are there any black holes? Are assets and liabilities fairly stated? Can the reported level of profitability be maintained? What working capital does the business need? Do management s financial projections appear reasonable? Where is the cash? Our transaction services team typically focus on the above questions but we invest substantial upfront time with our clients to understand their specific requirements and ensure we meet them. It is easy to gain answers to a myriad of questions on any business but interpretation and robust opinions are what really count. The skill and added value arises in helping our clients understand the critical issues and negotiate the best possible deal by focusing on those questions that really matter. Anindya Mukherjee, Project Manager, Roland Berger London office What facts should you be looking for in the due diligence process in order to make the post-merger integration as smooth as possible? To optimise the integration path, you must develop detailed plans ahead of time and have a clear understanding about how to cope with any cultural issues between the organisations. Due diligence investigations must focus on uncovering facts that enable you to plan concrete actions. For example, if the market for the target's services is growing in Russia, how should you organise and incentivise your new salesforce to maximise the opportunity? If gross margins are low and you want to improve procurement in which areas, how, and how much? Similarly you must uncover cultural mismatches and plan to harmonise them. For example, how are managers incentivised individually or as a team? If you need to change this, what actions will you take and how will you communicate them? One result of due diligence should be a detailed action plan that can be easily turned into an implementation blueprint for rapid integration of the two companies without destroying value Chris Kummer, Director of the Institute of Mergers, Acquisitions & Alliances What are the most important questions in the due diligence process? Of course you will usually follow the traditional procedure and check points from financial to legal aspects. They all are very relevant, but basically this is a no-brainer. The true art is shown when all details are put together like a puzzle to give you the whole picture. Because what really matters is to answer the key questions like those on strategic fit and the likelihood of post acquisition or merger success. Therefore it is important to staff team members with in-depth industry expertise, but who also know the acquiring company as well. The due diligence process must be truly output- and success-oriented. Matthew Farnsworth, Atkins Global For which acquisitions should environmental due diligence be considered essential? Why? FUTURE SUPPLEMENTS FROM MEDIAPLANET Today s regulatory regime rarely presents a business opportunity that is completely free from environmental risk. While seasoned acquirers acknowledge that manufacturing will carry a degree of environmental business risk; deciding when to perform environmental due diligence (EDD) can be swayed by false perception of the environmental issues and the need to close the deal. The decision of what is important is always best left to your environmental advisors, since legislation affects businesses and countries at different times. Can the inquisitive buyer be sure that the necessary upgrades have been accounted for, so as not to affect operational functionality? Operational delays will cast doubt on how well prepared the management team is in identifying their current and future liabilities and investors are unlikely to be understanding should the business soon require material upgrades because someone failed to consider environmental due diligence. The precautionary principle will always serve you well. FOR INFORMATION ON FUTURE SUPPLEMENTS CONTACT MEDIAPLANET ON , Wealth Management, Affordable Housing, Logistics, Pharmaceuticals, Cheese, Coeliac, Intellectual Property III, Chocolate, Obesity, CSR, Identity Technologies, Credit Management, Asthma, Vaccines, Stem cells The decision of what is important is always best left to your environmental advisors, since legislation affects businesses and countries at different times
7 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES 7 Operating ahead of the game Operational due diligence, in particular quantifying the upside, is becoming critical to winning deals in a highly competitive private equity market, says Martin Scott Dr Martin Scott is a partner, and the KPMG s operations practice in the private equity group As the private equity market has boomed, it has also become increasingly competitive. Five years ago, it was possible to make significant return by loading up a solid company with cheap debt available to only a handful of private equity firms and sweating the assets. Now, cheap debt is a commodity, thanks to highly competitive debt markets. It is increasingly rare for investors to have a unique competitive insight. Finally, sellers are becoming more astute. Anyone can win an auction by overpaying. To win safely, the buyer needs to understand the target s operations, what changes can be made, any synergies and to put a value on this. This has to be a robust case, underpinned by experience and facts, to convince an equity committee, or the funding bank, that this value can be delivered, and a higher bid price is justified. In the past, operational due diligence was a straightforward, kickthe-tyres sort of activity, required as a box-ticking exercise by the bank. Typically, the accountants would look over management s business plans and then apply some sort of sensitivity testing. Now, buyers need a much more sophisticated service. An operations team needs to identify the deal killers e.g. aggressive management plans that simply won t fly - and the deal winners - the unseen opportunities that might deliver, say, an extra 5 million to the bottom line. When factored into a valuation of, say, ten times cashflow, such an uplift translates into a chunky 50 million of additional value. That can be the edge a buyer needs to place a deal winning bid. Competition Increasing competition makes it essential that bidders search intensely for opportunities to create value. KPMG recently completed a survey of buyers. We found that 40 per cent of the performance upside is typically included in the sale price, and that proportion is trending upwards. In contrast, we found that only one third of buyers say that they did robust operational due diligence before the deal. A major challenge for them was finding robust advice on the potential upside. Specialist services KPMG has recognised this market trend, and the implication that the traditional approaches (and people) taken for operational diligence will not deliver the right services. Our response has been the establishment of a standalone specialist operations practice within the transaction services department. This team comprises highly-skilled deal practitioners, turnaround specialists, experts in lean manufacturing, restructuring gurus and authorities in cash management and the financial back office. We are able, with limited time and limited access, to get the numbers that the private equity house can use to model what it can pay. While much of our work is for private equity buyers, we have a fast growing practice among sellers. Many large corporates have been surprised by the way in which private equity houses have bought unloved business units and turned them into stars. They are realising that by scoping the operational upside in detail and sharing this with all potential buyers they have a much better chance of capturing some of this value in the sale price. Technical expertise When investing in an emergent technology, it is essential to call in an expert to assess it, says Graham Maile Dr Graham Maile All investors in technology-based businesses, whether a private equity fund general partner, a corporate investor or a bank, will have an interest in getting the due diligence right to protect their investments. It is often appropriate for the executives to seek outside assistance when they are dealing with technologies beyond the scope of their previous experience. The objectivity an external advisor brings to decision taking has other benefits too. Evaluation,valuation and value Technical due diligence has three important elements: Evaluation The fundamental feasibility of the technology which underpins the business needs to be thoroughly understood. Have all the risks been identified? What are the potential pitfalls in going from the lab to the factory? Is the product development team up to the task? Is the key intellectual property protected adequately? Valuation Technical due diligence is a vital ingredient in setting the amount offered by an investor for a business. On one occasion we at Plextek argued, successfully, during an acquisition that an offer for a business be reduced by over 60% because of a single hidden weakness in the target company s core technology. Value Technical due diligence can add immense value beyond obtaining a good financial deal. A second opinion is obtained on the feasibility of the target s development plans, product or technology gaps will be identified, and sector knowledge and contacts will be given freely to both investor and investee. Further, as most companies business plans contain more opportunities than can be realistically pursued within the management effort available, the due diligence process can help to identify the big opportunities, thus minimising the disruption-factor of activities that will dilute the chances of achieving the overall business strategy. Skills range We at Plextek have the range and depth of skills to be able to screen virtually any electronics-related technology. This can be at the level of the underlying technology or concept, right through to products, systems and manufacturing processes. The company can give realistic and informed views on the costs, timescales and resources involved in developing a technology to a point where it can be commercially exploited. Our international client list ranges from individual entrepreneurs to multinational companies including leading manufacturers, operators and silicon vendors such as Clarion, Denso, Marconi, National Semiconductor, QinetiQ, Smiths Group and Sony. Plextek is an approved supplier to a range of government departments and utilities including the DTI, Home Office, Ministry of Defence and Ofcom. Dr Graham Maile, Director of Strategic Consulting at Plextek, Technology sector specialist for Corbett Keeling, and Fellow of the Institution of Engineering & Technology.
8 8 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES Legal due diligence Legal due diligence is an essential to ensure that all is above board with the company you are acquiring The field of due diligence has exploded over the past few years, with all sorts of esoteric due diligence environmental, technical, personnel---now commonplace. However, there are still one or two types of due diligence without which even the simplest deal will not be done. One of those is legal due diligence. Just as you would not buy a house without a solicitor to do check the status of the deeds, no transaction should be done without comprehensive legal due diligence. Documents required The lawyers typically hand the acquiring company a standard due diligence check-list. Among the documents that your lawyers will want are: key contracts; employment agreements; minutes and consents of the board of directors and shareholders; confidentiality and invention assignment agreements with employees; corporate charter and bylaws; litigation-related documents and patents, copyrights, and other intellectual property-related documents. Questions to be answered Of course, due diligence is a twoway street. The vendor will want to establish the identity and residence of the buyer. The identity is important in determining the strength of any convenants. Residence matters because it will affect the enforceability of any agreements and the possibility of tax sheltering any profits arising from the transaction. The next issue is to establish the key assets the buyer thinks they are buying? Some typical key assets are: management or technical expertise; client or customer base; supplier relationships; brand names; technology, including intellectual property such as know how; production capacity; distribution network; land and buildings; regulatory approvals and licenses. The lawyers will then want to establish and, perhaps, influence the structure of the transaction. Is it a share purchase? Is the sale to be by auction or by private treaty? Are there tax considerations? What are the valuation considerations? Is the seller offering any indemnities? What sort of security are they offering for those indemnities? Is either the purchaser or the seller stock exchange listed? If so, what are the relevant stock exchange requirements? Are there other regulatory issues? Is either party in a regulated industry? If so, does permission need to be sought from the regulator? Are there competition considerations? If so, is it possible to get pre-approval of the deal? Are there any other regulatory issues affecting the transaction or the parties, e.g. foreign exchange requirements. TOP 10 LEGAL ADVISERS IN EUROPE YTD Based on all deals including lapsed and withdrawn bids, dominant geography of target and bidder being European, and YTD being 28 November By value Rank House Value (EURm) Deal Count 1 Freshfields Bruckhaus Deringer 347, Linklaters 290, Skadden Arps Slate Meagher & Flom 258, Clifford Chance 248, Sullivan & Cromwell 208, Allen & Overy 163, Davis Polk & Wardwell 161, Herbert Smith, Gleiss Lutz, Stibbe 145, Hengeler Mueller 142, Bredin Prat 138, By volume Rank House Value (EURm) Deal Count 1 Clifford Chance 248, Linklaters 290, Freshfields Bruckhaus Deringer 347, Allen & Overy 163, DLA Piper 20, Eversheds 7, CMS 29, Baker & McKenzie 42, Herbert Smith, Gleiss Lutz, Stibbe 145, Lovells 51, Foreign affairs However complex the legal due diligence of a western deal might be, there are far more challenges when doing a cross-border deal, especially in a country with a very different history or a less established rule of law. In Japan, for example, extensive cross-shareholdings are common. Moreover, and rather unsettlingly for western investors, legal documentation and practice is much less detailed than we are used to. The requirements of corporate documentation are often overlooked. No notarization is required for the transfer of real estate. And oral and unsigned agreements are common. In China, contracts with foreigners require a special licence. Wherever you do business, you always need a good lawyer by your side. Ensuring the right insurance Risk and insurance due diligence (DD) is more important than ever as private equity houses and banks seek comfort that their investment has a comprehensive risk management strategy appropriate to the business, together with an insurance programme which is prudent and effectively manages cash. The due diligence process itself has two main stages. The preliminary stage begins with the terms of engagement and a letter of confidentiality. Information from the data room, the target s management and other advisers is obtained. We may need to meet the target s management in order to resolve any potentially contentious issues. Risk management surveys are another option and can be valuable if an insurance marketing exercise is authorised and undertaken. The delivery stage consists of the report and a letter of appropriateness as well as possible implementation of an insurance programme. Risk report The report will establish the following: Risks associated with the business Total cost of risk (premiums plus self insurance) Gap analysis between a prudent programme that is cash efficient and the current programme delivering solutions where appropriate. Specific transactional issues Ever-changing external factors influence companies risk profile. Terrorism, political risks, industrial disease and an ever-more litigious environment all focus the minds of potential investors on risk and insurance due diligence. The increase in vendor insurance due diligence shows how important DD has become. Vendors acknowledge the benefits of a broker providing potential purchasers with a structured information pack and a commentary on the existing insurance programme in place. This however should not be just a copy of the policy cover notes. Transactional insurances Heath Lambert also place transactional covers such as: Warranty and Indemnity- insuring warranties given in a sale and purchase agreement. Tax Liability contingent liability insurance in the event that the Inland Revenue realigns a company s tax status. Prospectus Indemnity (IPO) a standard Directors and Officers liability policy excludes liability out of public offerings of shares or debt. When preparing for an IPO this specialist cover ensures continued protection for the directors and officers. Heath Lambert s experience Heath Lambert s Mergers, Acquisitions and Disposals Practice is a dominant force, working with over 50 of the leading European investment houses, accountants and law firms. In the past year we have advised 60 per cent of the top deals. Aggressive marketing of our clients programmes has enabled us to achieve significant premium savings, allowing the new company an excellent start. Furthermore, being a private-equity backed business, we are familiar with all aspects of a transaction, further enhancing our expertise. CONTACTS Alan Pratten, MD George Minoprio, Director Nairn Lickrish, Director Lorenzo Frediani, Director
9 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES 9 STRATEGIC INTELLIGENCE One of the most important factors to assess in any deal is: who is my counterparty? This is especially important when working in countries that may not have an established rule of law, or where fortunes have been made so quickly that the investor cannot rely on an established history or reputation. Therefore, the investor will want the right professional support answer the following questions: Who is this person? What do I know about this company? What do I know about their past? What do I know about the relationships they may have with government, with security agencies, with key players in the banking and commercial sector? In some cases, what is their relationship to organised crime? Arising force in this space is the London-based firm of Montrose Associates. Founded by former diplomat, Michael Maclay, in 2003, Montrose prides itself on being able to get at what Maclay calls, "the wiring diagram of power." Over the past three years, it has conducted assignments in many supposedly 'difficult' markets such as Russia, China, the Middle East and Latin America, but also in markets closer to home, where the wiring diagram can be just as important in the context of tenders, privatisations, and the current surge of M&As. Montrose's advisory board boasts a number of senior politicians, including former foreign secretary Lord Hurd, former CEO of Northern Foods Lord Haskins, and Mike Welton, chairman of Hanson plc. On his appointment, Mr Welton spoke of the quality of Montrose's work and "just how operationally useful it can be to international companies." Integrated environmental due diligence Looking beyond the obvious is always central to our approach. The provision of environmental due diligence as a part of wellintegrated advisory services is just one way of delivering more effectively, comments Matt Farnsworth, Head of Environmental Due Diligence Business Development at Atkins after a recent multi-site micro-electronics investment deal in Russia. Environmental Due Diligence (EDD) has come a long way since the days of solely looking at contamination issues and desk-top reports. Today s approach is radically different, more business oriented and altogether more integrated with other technical disciplines. The advent of new issues such as product liability, producer responsibility, carbon assets/liabilities and ethical supply chain due diligence have all grabbed headlines recently and are now commonplace R&D, board-room and marketing agenda items. What really adds value is being able to identify when and how new technical environmental issues such as these can be translated into advice that really matters to an acquirer, investor or operational business. We are not alone in this approach; financial advisory and legal teams will also have to grapple with placing either a cost or advising a position on a widening set of environmental business issues. This is why integrated advice is so important. Choosing a team that works together is key to a successful outcome. Recent initiatives, such as the UK Environ-mental Law Association s (UKELA) Corporate Due Diligence Working Party (which Atkins helped establish) is an example of how businesses can work together. The working party Matt Farnsworth, Head of Environmental Due Diligence Business Development at Atkins brings together transaction advisory professionals from across the various banking, financial, legal and technical sectors to help foster best practice, common approaches and sharing of ideas between disciplines. The result? Time will tell. Matt Farnsworth can be contacted at: Due diligence and secure deal rooms Virtual secure dealrooms offer huge advantages in doing deals, says Brainloop s Oliver Gajek As recently as five years ago, companies doing mergers and acquisitions (M&A) would maintain a physical dataroom, in which all the commercially-confidential documents that might be of interest or relevance to interested parties would be held. Clearly, any potential buyers had to travel in person to consult the confidential documents in that data-room, imposing huge barriers of time and energy on them. And, access to the data-room was dictated by working hours. The advent of the internet, ubiquitous broadband and secure encryption has made possible virtual datarooms. These first emerged around five years ago, but have become the de facto standard over the past couple of years. Open all hours Our secure datarooms offer a number of clear advantages over the physical variety. First, the potential field of buyers can be much wider if they do not have to establish a physical presence where the physical data-room happens to be. Therefore, you can have many more international buyers a must in an increasingly-global world. Second, the deal process can be accelerated. Instead of having a data-room that is open only during office hours, our virtual datarooms are open 24/7. Third, they offer easy access to all parties working on a transaction. Bernhard Winterstetter, certified public accountant, tax consultant and partner with Peters, Schonberger und Partner, says, Our M&A projects benefit tremendously from immediate access to a fully-functional virtual deal-room application. All relevant information is available online, 24 hours a day, worldwide and simultaneously for many bidders. Easy access and reduced travelling times accelerate due diligence considerably Information control A virtual data-room allows vendors to control exactly what information each potential bidder sees during the due diligence phase. Moreover, because Brainloop can track exactly which documents have been seen by potential bidders, our customers are protected in the event that the successful bidder tries to claim that certain information was withheld. Sellers want to ensure that they can show the documents that they have disclosed to bidders under warranties clauses. Brainloop Secure Dataroom delivers a secure communication platform, where exchange and viewing of documents occur in a secure and encrypted audit-proof environment. In addition to other security functions, the automatic watermark feature prevents unauthorized forwarding of confidential documents, Mr Winterstetter attested. Brainloop finds that there are a few different types of client. One is a company selling a subsidiary and looking to solicit bids. A second category that is becoming bigger and bigger is activity in real-estate portfolios. Companies are increasingly rearranging their real estate holdings, moving them off their books and turning them into cashflow. Brainloop secure datarooms can facilitate the process. Oliver Gajek is chief executive of Munich-based Brainloop, which provides electronic datarooms
10 10 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES SuperReturn celebrates anniversary Eli Talmor presents new research for SuperReturn 2007 On the 10th anniversary of SuperReturn in Europe, we want to encourage a little robust self-analysis, and not just because of the UK Financial Services Authority s recent discussion document. The regulator is concerned about the increasing size of private equity funds, the extent of leverage and capital movement from the public to the private equity. However, despite attempts to enforce transparency and facilitate shareholder activism, interests in publicly-traded companies are not wellaligned. By contrast, corporate governance in private equity-owned companies is a breath of fresh air. In my retrospective review of the industry evolution, I will be looking for systematic patterns rather than the incidental ones. But I don t want simply to look backward. I will examine where the industry can play a key role in the future. The focus of private equity now is to identify business opportunities in an environment where the parameters cannot be changed or influenced. I believe that it is time to switch that mindset. It is essential to look at the big picture and for the private equity community to make a lasting impact on mankind. This should be possible given that the sector has attracted such an impressive pool of talent and continues to demonstrate creativity, innovative management practices and resourcefulness. SuperReturn takes place in Frankfurt, 26 February to 1 March The conference attracts around 1,400 international private equity professionals and investors, and more than 200 speakers on topics such as: Private Equity: Going Back To The Roots Strategies For Successful Buyout Investing In The Age Of Excess Capital Mid Market Versus Large/Mega Funds Distressed Debt Opportunities How Big Can Deals, Financings, Funds and Fees Get? The Convergence Of Hedge Funds & Private Equity Private Equity & The Public Good VC and Buyouts In China Limited partner/general partner relations Agony or ecstasy: What s ahead for VC over the next 10 years? Secrets to Success In tech Transfer Changing Role Of Mezzanine Main Developments In Secondaries Pros & Cons Of Private Equity In The Listed Domain Allocations To Infrastructure Improving Performance & Value Of Companies The conference include interactive panels and head-to-heads with: Alan Patricof, Apax Partners David Bonderman, Texas Pacific Group Stephen Schwarzman, The Blackstone Group Mario Giannini, Hamilton Lane Sir Ronald Cohen, Bridges Community Ventures David Rubenstein, The Carlyle Group Nigel Doughty, Doughty Hanson Scott Sperling, Thomas H Lee Partners Johannes Huth, KKR Jonny Maxwell, Chief Executive, Standard Life Investments Jon Moulton, Managing Partner, Alchemy Partners Guy Hands, CEO, Terra Firma Capital Partners Professor Eli Talmor, Academic Director, Private Equity Institute, London Business School. The value of vendor due diligence Many financial directors do not consider vendor due diligence when selling a business; but it means they can stay in control of the process, says BDO Stoy Hayward s Chris Grove Most people are familiar with due diligence. A company being sold is descended upon by accountants and other experts who spend weeks looking at the business to establish if it is what it says on the tin. Recently, however, vendor due diligence, has become increasingly popular in the mid-market. Instead of potential buyers conducting their own investigations, the seller commissions an independent expert to report on the business warts and all. Essentially, vendor due diligence is an independent and thorough review of a business being offered for sale. It is a detailed assessment of the business and should address questions likely to be asked by potential purchasers. Once the preserve of mega-deals, practices like vendor due diligence are increasingly seen in the midmarket, thanks to competition among private equity houses. Maintaining competitive tension throughout the deal is key to securing the best price and this is where vendor due diligence can play a crucial part. To VDD or not to VDD? BDO Stoy Hayward recently conducted a survey of finance directors to evaluate attitudes towards vendor due diligence. Half of the finance directors surveyed said they would not consider vendor due diligence. This may reflect a lack of understanding as vendor due diligence brings two advantages to the seller. The first is that the sale process is more streamlined and efficient. Instead of having six or seven sets of advisers crawling over the business, the vendor can control the process, ensuring all parties receive the same information, while maintaining competitive tension. Recently, one of our clients sold a subsidiary in a highly-sensitive market. By conducting vendor due diligence they ensured that commercially-sensitive information did not leak, which would have damaged valuable customer relationships and, ultimately, the value of the business. No price-chipping The second benefit of vendor due diligence is arguably more important. By disclosing all the salient information about the company upfront ( warts and all ), the vendor discourages potential purchasers from engaging in price-chipping further down the line. All too often, acquirers try to reduce the price in the final stages of negotiations. Some argue that, by its very nature, vendor due diligence is never fully independent and, therefore, can have only limited value. However our experience shows that, providing the adviser is truly independent and credible, potential acquirers will trust and rely on the information provided. Interestingly, in the BDO survey nearly half of finance directors considering vendor due diligence said they would instruct their auditor an odd choice given many also recognised that the most valuable attribute of vendor due diligence is independence. Directors selling a business should put themselves in buyers shoes: would you be comfortable instructing this adviser? The requirements of independence and credibility limit the choice of adviser. Many of the larger firms may be conflicted due to audit relationships. However, reputation, independence and sufficient scale are key attributes for any firm undertaking Chris Grove is a corporate finance partner at BDO Stoy Hayward vendor due diligence, if the exercise is to be of any real value. But, get it right, and it can save time and money in the long run.
11 AN INDEPENDENT SUPPLEMENT FROM MEDIAPLANET ABOUT DUE DILIGENCE, DISTRIBUTED IN THE TIMES 11 No nasty surprises Insurance due diligence is crucial, not just to ensure that the new company emerging from a deal is covered as efficiently as possible, but also to avoid any nasty surprises, says George Minoprio CARVE-outs where a subsidiary or even a division of a larger group is spun off as a separate entity are becoming increasingly common. With a huge number of private equity houses competing to buy medium-sized businesses, many of their owners are asking if they might not be better off taking the cash. However, carve-outs pose particular management and valuation challenges. In particular, the exact liabilities and risks that such a company bears may have been subsumed in a larger insurance programme. That is why we at Heath Lambert have been called in on 60% of deals done over the past year in order to advise on whether the emerging company the newco in the jargon is appropriately covered. Assess the cover Our first step is to assess the cover that is already in place. We assess whether the programme is appropriate to the risks that the company faces. We check if there are any gaps in cover, and try to evaluate the cost of filling those gaps. We look at the company s claims experience. We compare the cost of the programme in place and also the implicit cost of the self-insured risk. This gives a total cost of risk. Best practice We compare this programme to what we would consider best practice. We negotiate aggressively on our clients behalf to put in place the best-value programme. Different deals have different insurancerelated requirements. Banks will often require insurance due diligence as a condition for offering finance We look very closely at directors and officers insurance because, in a deal, D&O tends to go into run-off when there is a change of owernship. We sometimes try to get D&O insurance to roll over. This will be a key part of the sale & purchase ageement. Different deals have different insurance-related requirements. Banks will often require insurance due diligence as a condition for offering finance. Liability management Just as important as the insurance cover is the tricky question of liabilities. When a whole company is sold, all the liabilities go with it. However, in the case of a carve-out, the acquiring company will want to leave as many liabilities as possible with the parent company. How much it s worth to do so will depend to a large extent on the assessment of liabilities. Insurance policies tend to pay out on claims in one of two ways. First, they pay out on an occurrence basis, ie the policy pays out regardless of when the claim is made, under an historic policy. The second method is when claims are paid on a claims-made basis. In this case, the newco should try to ensure that the parent company either assumes all historic liabilities or agrees to arrange run-off cover. This is a key negotiating point. George Minoprio is director at Heath Lambert s Mergers, Acquisitions and Disposals practice After the deal The deal has been completed, the contracts signed, the last dregs of midnight oil have been burned and we can look forward to the success of our newly acquired company. Or can we? This will depend upon both the quality of execution of the due diligence, and the delivery of the acquisition plan. Once the initial euphoria of winning the prize has worn off, the hard work actually begins. Although due diligence has identified opportunities to create value, as well as ensuring that there is no black hole, these opportunities still have to be delivered to justify the price. During the acquisition process the purchaser and the seller are rivals. One is seeking to minimise the price paid the other to maximise it. One is seeking to highlight potential opportunities to boost future earnings, the other wants to pay only for certainty. Management of the acquired company has split loyalties, with future insecurity playing heavily on their minds. After completion of the deal everything has changed. Acquiror s and acquiree s management are now on the same side; there is no more hedging about what can be achieved; incentives are aligned. How can one take advantage of this new situation? Great value can be created by working with experts immediately post-acquisition to agree with the acquired company s management more precise targets for the future. Now that management understands the cultural environment it will be working in and how to behave, substantial future profits can be realised. How does this happen? A truly successful acquisition does not come from delivering the plan developed at the time of acquisition, although this is often challenging enough. Further value can be created by a rapid cooperative review of key elements of the business immediately after the deal has completed. Ambiguity There are often multiple areas where the conflict at the time of due diligence has led to ambiguity and lack of clarity about the future potential of the business. Immediately after the acquisition the due diligence must be revisited with the acquired company s management. Were the assumptions about future growth potential correct? Can the business make more effective sourcing decisions? Is the supply chain as productive as it could be? Are production facilities optimised? Can working capital be reduced? Is the salesforce organisation appropriate? All of these issues will have been tested during the due diligence period of the acquisition but a better result will be achieved by challenging them and reinvestigating them after completion of the acquisition. How is this best done? As with due diligence, one should use advisers who are experts in the field. This can be in either the specific industry. or the function. or both. Either way there is a window of opportunity immediately after the acquisition to create value, a window that may David Stern, UK managing partner, Roland Berger not be repeated once the acquisition is lost in corporate history and the normal tensions of running a company take over. Expert acquirors are aware of the potential from this honeymoon period after the completion of the deal. Other companies can learn an important lesson from this.
12 Why does the average due diligence report* seem** to come with quite*** so many caveats?**** Most due diligence reports are precisely that. Diligent, but nothing more. The trouble is, many accounting firms can t see a fence without sitting on it. In our view, due diligence should come with a point of view. That s why we offer something you rarely see. An honest opinion. For further information on how our due diligence team can help you please contact Chris Grove on +44 (0) or 'Global Firm of the Year' 2006 'Employer of the Year' 2005 BDO Stoy Hayward LLP and BDO Stoy Hayward - Belfast are both authorised and regulated by the Financial Services Authority to conduct investment business.