Financial buyers have definite advantages over corporate buyers in the area of strategic due diligence.
Our strategy development team has worked alongside the best private equity partnerships. We focus our clients on asking and answering the big questions. Sellers have a reason for selling. You need to know what you are buying and how you will make the business more valuable.
For start-ups and mature businesses alike, IP can be used to fuel growth, expand into new markets, and attract major investments. While a robust IP portfolio can detail a company’s inventions and business objectives, the scope of coverage the IP portfolio affords can be extremely complex and difficult to understand.
Intellectual property due diligence is a critical component of monetization, mergers and acquisitions, negotiating purchase terms, and preparing exit strategies, public offerings, and private placements.
Strategic due diligence adds an important deal-screening filter. Executives must be convinced not only that the potential deal value justifies the significant investment being made, but also that the business is truly capable of realizing this value. Indeed, a sober strategic due diligence evaluation should help set the purchase price. The buyer should demand a price that is commensurate with the level of integration risk uncovered and be willing to walk away if that price isn’t met.
Two Big Questions
The first question, testing the commercial attractiveness of a deal, involves validating both the target’s financial projections and any identified synergies using an external lens. Companies can achieve this by assessing overall market attractiveness and the competitive position of the target, and how these might change over time.
Whether the buyer is out-of-market (e.g., a financial buyer) or in-market (e.g., a competitor), this analysis is indispensable. However, for an in-market buyer, the commercial attractiveness issue may be more complex. The due diligence team involved in an in-market deal must gaze into the future and calculate the competitive position of the combined entity, including its impact on customers, competitors, and overall market dynamics. (Will the merger invite new entrants, for instance?) After all, customers and competitors will react to the merger in ways that will benefit them — ways that might threaten the combined businesses’ value-creation assumptions.
As for the second question, a company must make a hard internal examination of whether the targeted value of the deal can be realized by the management team of the combined enterprise, and, if so, whether the projected time frame is realistic. For an in-market merger, it is vital that all the associated risks, in terms of customer and competitive responses, technology issues, and culture challenges, be weighed. When they have been weighed, the salient question becomes, Can these potential risks be managed? If preserving increased market share is a key driver of value, for instance, leaders had better be sure that the executives of the new company know their customers’ needs, can meet them, and can fend off competitors who will surely try to pick off customers and clients during this period of uncertainty.
Although testing whether a company has the capabilities to realize projected synergies is particularly important when it involves an in-market merger, out-of-market purchasers are well served by a similar internal analysis that helps them understand the key drivers of value in the target company (people, technology, specific customers) and what the key management requirements will be in the new organization.
The Deal’s Rationale
To focus strategic due diligence, it’s necessary to pinpoint the value-creation opportunities of each transaction. To assist in this process, we have identified two dimensions that influence the strategic rationale and underlying value-creation focus of a deal. These two drivers are shown in Exhibit 2. On one axis, the degree of integration between acquirer and target drives the size and number of potential synergies. On the other, the relative sizes of the acquirer and target influence whether “best of breed” solutions from either company will be adopted, or whether the target will simply be absorbed into the acquirer’s business model.
Mergers that are intended to strengthen current market position or that seek new growth opportunities by either entering a new market or developing new capabilities all have their own unique “degree of overlap” and “relative size,” but we have found they fall into one of four categories when we perform this analysis. We have named the categories in-market consolidation, in-market absorption, out-of-market transformation, and out-of-market “bolt-on.” Our four categories are broad, but we believe they are useful groupings that can serve as starting points for shaping any strategic due diligence effort.