Diligence in M&A

I'm Kisam Patel and you're listening to M and A Science, where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during MA deals. So my name is Kisan Patel and the podcast I host is called M and A Science. Today I'm here with Jeff Deroche, who's VP of Corporate Development at Atlas Copco, a 10.5 billion industrial equipment company based out of Stockholm. Jeff has been managing M and A and other inorganic growth initiatives for over 10 years, primarily focused on the industrial manufacturing, semiconductor and life science markets. Prior to Atlas Copco, Jeff spent 12 years in corporate development, product marketing and project management roles. He started his career as a process engineer for Intel. Today we're going to talk about best practices for managing an effective diligence process. How are you doing today Jeff?

I'm good. Thank you for the invitation.

Can you start off with briefly explaining your role at Alice Copico?

Sure. Well, I primarily focus on driving inorganic growth for Atlas Copco, so I work closely with our business leaders to develop strategies for how they want to grow their business and then those strategies tend to take both organic and inorganic substrategies for which to grow and then typically I'll drive the inorganic initiatives so ones including anything from mergers and acquisitions to joint ventures, strategic collaborations, could be licensing as well as some divestitures here.

And there's what are some of the approaches you take when it comes to deal negotiation strategies?

Well, you know, actually I'll put in a plug for your for your podcast I want to borrow a one of the concepts that I believe was John DeRosa from, from Cisco talked about with respect to integrations. Great podcast. I highly encourage everyone to go in and listen to it. But he talked about the use of, of, of empathy in, in the integration process primarily focused on but I use, I use that very much early on in the process. I try to use empathy as a, as a tool for which to approach when I'm approaching tends to be middle or lower mid market owners of businesses. I try to, as the word would suggest, put yourself in their position and try to try to understand what their needs are, what they're looking for out of a potential deal. I think it's important to be able to understand, you know, know their vision for what they want to do, whether they're going to stay with the company or potentially leave right off into the sunset of retirement or taking a more active role. And what are you going to do with the business? Right. What is Atlas Copco or Whoever they're talking to going to do from a people perspective, from a facility perspective, other parts of the business, that tends to be very important to small business owners. So again, I find that using the empathy as a tool can really help you to position yourself well and to appeal to that owner to try to have them sell, not only sell their business, but sell it to you.

So put yourself in their shoes and really get into their lens in terms of what they want to see as outcomes.

Exactly, exactly. And you have to keep in mind that this may be the only time that these owners have ever had any exposure to the M and A process. There's some cases where you've got some serial entrepreneurs that have sold their business multiple times, but for the most part, this is the only time that they'll have done. And these are, they're, they're obviously very savvy business operators. Generally, we're looking to buy good businesses and therefore these owners have done a great job managing their business. However, they, they don't have much exposure. So they have, along with the unknown, they have a lot of apprehension about, you know, how is this process going to work and what are you going to do? What do I have to expect? How much is it going to disrupt my business? Potentially all kinds of, all kinds of things. And of course, in there is, is, is how is the deal going to work? How much money am I going to get to, you know, maybe if they're going to retire, how much money are they going to be able to live on for the rest of their lives? And what kind of role will they have in the, in the, in the business, if any? And all these things are, all these things are really critical to try to understand so that when you, when you do make your offer to them and when you explain to them the way that you're looking at the business, you can appeal to, to all those, all those different priorities that they may have.

Well, how much do you present an offer and prepare yourself for any responses you may get?

Typically, I think many times one of the responses is going to be, that's too low a price. That's a very common one. But again, using that tool of empathy, you can try to position yourself so that it's not just based on price. And this is one of the distinctions I would make between sometimes, at least the way we approach it, certainly in corporate strategics, approach acquisitions versus sometimes private equity. And the feedback I get from other owners sometimes is that they'll say, we get calls all the time. They get inundated by phone calls from companies looking to buy their business. And oftentimes they describe it to me as sort of a boiler room operation from private equity folks that don't understand the business necessarily. They don't really care that much about the business. They just want to buy the company for as good a deal as they can. And what we try to do, and I know that's unfair generalization of course, but again, that's been the view of some owners that we've talked to. And what I'll try to do is position us very differently from that. Right. That we're looking to be good stewards of their brand, good stewards of their facility, their people who they may continue to be, you know, they want to continue to be, to be friends and neighbors with going forward. So always getting the top dollar isn't necessarily the most important thing that the owner is looking for. Although of course they all want to get as much as they can for the business.

So looking past just the dollar figure and finding the other drivers of the deal.

Yeah, yeah, absolutely. There's a lot of different levers that you can, that you can pull, as I say, the way in which you're going to treat their brand. Are you going to convert everything over to your brand or are you going to keep their brand? And you know, we often keep our brands and manage this multi brand approach. What are you going to do with the people? You know, there's some models out there where acquirers will try to, you know, really dramatically and reduce headcount, kill R and D projects and things like that. That's not our model. You know, there's a, there's a place for that in some cases. But what we try to do is to find good businesses and then invest in those, in those businesses. So we want to hire more people, we want to build more facilities, we want to invest more resources in that business and grow it. And to a lot of owners, that's, you know, that's really important. Of course, you know, you get some owners that will say, you know, I, I don't care that much about that. What I really want is as much money as I can get because I'm going to go off and retire on the beach somewhere and you know, that's okay too, it's their business. But we just want to understand that and we want to be aligned and honest with each other as far as how the deal is going to progress.

So taking a step back, what are the main priorities of diligence? What should be the goal for the outcome yeah.

So as you say, taking a step back and looking at diligence as you're transitioning into that diligence process and trying to build this collaborative environment where you're aligned with your seller on how the process will, both the mechanics of the process and the goal of the process. I think you first of all think about what the main priorities are of the diligence process in general. Right? It's to verify initially verify all the assumptions and all the information that you got before you got to that diligence stage. And then secondly to perhaps even more important is to minimize your risks, identify any potential risks going forward to you being able to successfully execute that business plan. And those risks can take a lot of different forms. But I think those are the two main goals that you need to, you need to keep a focus on. And then you know, when you're coming out of that process, the idea is that you've got, you've got a business case that is much more strengthened now, has a stronger foundation in terms of its ability to, your ability to achieve those goals and minimize any, any potential risks that.

What kind of issues have you seen come up during diligence?

Yeah, well, as far as you know, businesses of this, the kind of the mid and lower mid market size. I think, you know, one of the common ones that you, that you'll see in, in diligence is perhaps accounting practices aren't as sound as you know, as a larger company might employ. So that's, that's a very common one. The inventory management is, is one that comes up quite often. You'll see that business, smaller business owners don't often maybe appreciate the, the amount of capital they've got tied up in, in that, in that inventory and they've got perhaps it overvalued or they've got a lot more than they really need to run the business efficiently. The flip side of that in their defense is that oftentimes they'll say, well you know, my customers call me because I have this, I have all this inventory and I can turn it around really quickly. And there's a point to be made about that. But nevertheless, you really want to be smart about inventory management and how you do that efficiently. So that's just one, you know, that's just a couple of common areas. Another one is related party transactions. You know, the vast majority of smaller company owners that I run into own the real estate through a separate, oftentimes through a separate llc and they'll, they'll have lease agreements or no lease agreement. As it, as it is sometimes in place handshake agreements at well above market or below market rents, depending on what their goals are. And of course, they're always trying to sort of maximize their tax efficiency, if we put it that way. And sometimes that's, you know, those are things that are fine if you know about them. And you hope that, you know, in this collaborative diligence process, your, your, your seller is being completely open and honest with you. And vast majority of the time that's, that's the case. But you do need to look out for these things because they, they tend to come up.

What are some surprises? Just examples of things that you were sort of caught off guard in terms of what you find unexpected in a diligence process.

Yeah, well, over the years, we've seen a number of unique, unique things come up. I think one where, you know, it's not uncommon to have family members in the business. Right. In fact, it's more common than not. There'll be at least a few family members. I think, though, if you run into a business, for example, that has half of the company of, you know, a company of maybe 30 or 40 people is all family members or either by name or by marriage, and then in addition to that, all of the executive team is family members. I think you, you have to really think carefully about how you're going to manage that going forward. Right. If, if you do an integration of the company and you expect most of those people to stick around and you can put retention agreements in place and so on, then you really need to be concerned about one issue happening in one part of that network, affecting all the rest of it. And these are the people who, you know, have such a critical, play such a critical role in your business. So that was a, you know, that's a surprise that, you know, can be challenging sometimes. Another one we had, we bought a golf membership, a country club membership, one time in, with, along with a company. It, generally that's not something that we would, we would buy as part of a, of a balance sheet. But it turns out that in Korea, country club memberships are appreciating assets. So we said, okay, well, we'll pick a different battle to fight and we'll go ahead and just buy this country club membership and we'll, we'll treat it as a perk until maybe we, we sell it off at some later date. But we decided not to fight that battle.

What's the surprise you found that killed the deal?

A surprise that killed the deal? Well, we've certainly Had a number of, I think, litigations come up that perhaps the seller's view of how critical a litigation might be versus what we view it as could be a little bit different. Right. And I've heard lots of owners tell me, oh, yeah, that's, you know, we discover something, and they hadn't necessarily disclosed it earlier on, and they say, oh, yeah, it's no big deal, though. We'll get that worked out. You know, okay, I'd love to take their word for it, but, you know, as, as a. You wouldn't be doing a proper fiduciary responsibility if you didn't. If you didn't treat that with a, you know, a bit more focus and make sure, you know, along with all these other risks that, that I, that I mentioned, all of these things are manageable, right, to, to one degree or another. And it's a question of how much risk are you willing to take on and, and, and do you have mitigation strategies? And that's really a key part of it is it isn't that I don't think our executive team necessarily ever expects to see a deal that's completely clean, it doesn't have any hairs on it or anything like that. But what they expect to see is if we propose to move forward with one, that we've got a mitigation strategy for that. And it can be very extensive or it can be quite simple as well. But nevertheless, you have to have thought through those things. You want to make sure that, as I mentioned before, you identified everything, and then if you're going to recommend to go forward that you've, you've tried to mitigate those.

Do you think the mechanics of diligence or the unexpected issues cause more friction during the diligence process?

You know, it's, it's an interesting question. I'm not sure. I'm not sure that there's necessarily a percentage on whether it's the mechanics or the issues. As much as you can. You can expect to, to have challenges. And the mechanics sometimes to some degree are a little bit easier for me to deal with in the sense that I can work with the, with the owner, I can work with our team, and I can try to, I can try to minimize. Certainly want to minimize the impact on their business. Right. Diligence is something that, you know, companies don't do all the time, and they are being asked to dig up a lot of information that, you know, maybe they have easily at hand, but maybe they don't, and they're asking their people to Take some time out and, and spend with you. So, you know, managing the, the mechanics and the demand on the seller's time. I, I can usually manage that fairly, fairly easily or sort of fit it to, to, to, to work better with their, with what they're able to do. The, the unexpected issues are a little bit more of a, of an unknown by definition. And I, but to be quite honest, I think maybe we've just been lucky in that we've run into a lot of sellers that are very, very collaborative, very helpful, very honest, very, about everything up front and we don't get support surprised too much with really serious unexpected issues.

What's your approach to handling or dealing with those unexpected issues?

Yeah, well, first you certainly need to again expect them something to come up. I mean it's just a unicorn deal where there aren't any issues. But again, I would hearken back a little bit to the empathy aspect that I mentioned earlier. Obviously you want to make sure that you pull in whatever experts you need to address that particular issue. If it's technical, pull in your technical team. If it's legal, obviously you've got your, your legal team there and so on. But I think that, you know, you need to try to jump on the issue and putting it off or somehow minimizing it is definitely a recipe for disaster. So I highly recommend not, not doing that. Take all the, the issues seriously, even if they're minimal. Make sure that you address them. If you need a mitigation strategy, then you've, you develop that as well.

So one of the things I've seen a lot of conversation around the past few years is around culture. Yeah, I've never heard of anybody walk away from a deal because of culture. I'm curious to hear your views around that.

Yeah, I think culture's. Well, first of all, I'll say it's absolutely critical. However, I don't know that the M and A process over time writ large that is has matured to try to improve the way it assesses and manages that culture. I think a lot of the data that you see about integrations being the primary reason for the failure of deals or deals not meeting their original objectives is because of this poor cultural fit that is discovered only once. Kind of the rubber hits the road in the integration process and there's things you can do. I don't mean to say that the industry isn't anywhere in terms of that, the cultural mapping and different kinds of assessments and so on, but I think there's still a tremendous amount of subjectivity in that process, in that assessment, those assessments. I think we still have a lot of improvement that we can do in the cultural fit aspect. Cool.

So it's becoming more of a conscious thing to be aware about.

Absolutely, absolutely. As I say, I think it's critical and that we can do a lot more around that space. But again, it's tricky because it's not like checking a box on a due diligence list or evaluation model, which is very quantified. This is much more subjective.

What's the craziest thing you've seen in M and A?

Yeah, well, some of the things I mentioned earlier, maybe the golf membership thing was a little bit odd. We had. Normally when we do diligence, I don't think it's all that different from anyone else. We'll, we'll have a, you know, reserve a room in a hotel somewhere or a conference room or somewhere locally. Sometimes we've done it in our offices or the seller's offices recently. I had one though where the seller said, oh, no problem, we'll go ahead and have it in our, in my house. And I thought, oh, this, that's probably not a good idea to have it in someone's house. It turns out though, he had something that he called a man fort. So you've heard of man cave, right? And TVs and some things like that. And that's all great. But this was not that. This was a legitimate separate building that he added onto his house that had. It certainly had plenty of room for a conference. We had a large conference table. We had eight or 10 people there at any given time. Projector. That was all great. But he also had next to that a large commercial bar. It was just as if you walked into your local, local pub. Which made the transition to happy hour at the end of the day really, really smooth. He had, he had a full on theater in one part of this, this building and in the mezzanine in the upper areas he had a, a workout gym and a, a recording studio all in this what he called a man for. Oh, a commercial kitchen too. I forgot to mention that. So he had his, his collection of high end bourbons as well over there. So that was, that was an eventful and memorable diligence process.

I have a new goal to aspire to is to have a man for it.

I didn't even know they existed until I saw this is very impressive.

With that I wanted to open up. If anybody had some questions. Ask Jeff anything.

I think you asked, are there specific types of investments that we would run from. Yeah, there's probably more of those than there are ones that we would, if we would do. I mean, as you know, this is not uncommon with a strategic, with a corporate right in that we have a. We work closely with our business colleagues to develop our strategy. We have a, of course, an overall group strategy in directions we want to go. And then within each of the divisions, we also have divisional strategies and we have, we use a couple different sets of tools where we try to define the types of companies that we would find attractive and the characteristics of those companies. So I know one of the fellows in an earlier panel talked about being, I think it was industry agnostic. We are not that there are, although we do work across a number of different industries. Tends to be industrial manufacturing, chemical processing, construction, mining, some semiconductor as well. But, you know, things that, things that would really make us concerned. Well, we also have a fairly high operating profitability. So to dilute that very significantly is another, another potential knock against doing a deal. But there's a whole list of criteria that we try to go through and you don't have to check off every one of them necessarily to make a company attractive, but you want to get the plurality of them and you want to, you want to see how you can, how you can get the company to achieve those other, those other characteristics.

Well, everybody else, don't be shy. Jeff's bill rates definitely high. It's a chance to get some free advice. What is the hardest part of your job?

Hardest part of the job? Well, I think sometimes, first of all, I really do enjoy it and it is a bit of a unique. I know everybody says that, but they enjoy their job. But corporate development in general is a very unique role. That's a bit of a. It requires some jack of all trades skill sets that you put together because you got to understand, you know, how business works and you've got to understand finance and you've got to understand a little bit about a lot of different aspects of business. Product development, operating efficiencies, Lean and Six Sigma. You've got to understand legal aspects. Right. You've got to know about purchase agreements and Lois and all different terms within those. And as well as finance, of course, a lot of my colleagues in corporate development come from an investment banking background or a PE background and obviously they typically have deep finance abilities and to be able to develop your own financial models or to, even, even to build them according to a template. So I think there's a lot of different things that I like about, about the role. Sometimes it's a little bit hard. And it goes back to maybe the previous question to find. Sometimes you feel like you're a bit of a unicorn hunter in order to find companies that, you know, fit all of your, your strategic and financial criteria that you're, you know, that would then get a deal over the, over the finish line. So I wouldn't say it causes me a lot of stress, but it certainly is a. You know, probably one of the more challenging parts of it is really to find the company that is going to match all those criteria. That said, we do quite a few deals each year, so we do find them.

That's the hardest part for a job, is just finding the right deal.

Yeah, that's, that's probably true.

Anybody else have questions? You know, one thing I'm curious about is measuring success. And I feel like companies have a very different definition of that. And two, I know you mentioned you run your companies as separate brands. A lot of organizations out there will end up integrating it. And once you integrate a company, you're combining P&Ls and things get pretty foggy at that point. So I'm curious to know, what's your criteria for defining success on your deals?

We say, to Atlas Copco's credit, and this hasn't necessarily been true with all the organizations that I've, I've been exposed to in the past, we do a pretty good job of tracking that. So we tend to, we have, of course, a set of financial criteria tied to our original valuation model. So the business case that we developed in the beginning, we're going to look at that after we look at some of the criteria every month. But we do sort of a more thorough analysis after 12 months and 24 months or so to see how well did we do against those, against those criteria. So of course we try to do a. Lessons learned after deals. Deals finish as well because you'd like to like to carry that knowledge forward and not repeat the same mistakes if you can avoid it. But I think we generally do a fairly good job of looking both quantitatively, you know, did we, did we hit our objectives and then qualitatively does that business now or that product line or however we, whatever approach we took to integrating it, is that, is that playing the role that we intended it to play? Sometimes, you know, it's not necessarily. We don't necessarily just buy a company and bolt it on, but we might buy it because we want to step into a new area and then build its business off of that. It's A new platform for us, for example, and we want to grow. So a qualitative assessor, strategic assessment of that might include did it act as the foundation? Did it actually play that role? Were we able to leverage that to grow further into those other, those other markets? So we, we definitely try to take a look back not only on a short term basis but on a longer term basis to see how well.

So you do track them. So it's definitely more benchmark financially. And you do track them for a period of time after.

Yeah, yeah, absolutely. Very, the foundation of that tracking is very qualitative, sorry, quantitative assessment of how well did we do against the projections from the business case and the valuation model in particular with the particular emphasis on return on capital. That's, it might be interesting for some of the folks to, to look at. We, we obviously, you know, profitability is, is a key criteria for us but, and, and, and revenue growth. But all of that sort of eventually feeds into, you know, are you running an efficient operation? Are you managing your shareholders capital appropriately? And, and that's what we, that's sort of tends to be the, one of the main criteria that we end up looking at.

You mentioned lessons learned and a lot of companies talk about that. We have post mortems and we grab our learnings. How do you take that and actually put it to use? So people are conscious about these lessons learned going into the next deal because I feel like at the end of the day it ends up in some repository somewhere collecting dust.

Yeah, that's always the risk with lessons learned. Well, I'd say first of all it's a good step to see a company that actually does them right. There's, there's no shortage of companies out there that just, you know, finish up one deal and move on to the next. So what we, we certainly do do that in the sense of, you know, collect up the information from the team members and, and get everyone together and there's, you know, when you've got the team together, talking through, talking through your lessons learned as opposed to just, you know, email me your comments. Kind of a, kind of an approach, then you really, I think have a, have. There's a synergy that happens among the people, if I can use that term, where someone comes up with a point and it triggers a thought in another person. So you want to collect all those. But then as you say, if all you do is file that in your hard drive somewhere, what good is it? So you want to take that out periodically as well and say okay, what are some of the common things, I think that's the most useful one is not necessarily specific to each other, to each deal, but, but more commonly, once you've done a few acquisitions in a particular division or in a particular area, what are some of those lessons learned that you've seen that kind of cross those boundaries and how do they apply to this new deal that you're, you're looking at? So it really does take a conscious effort.

Sorry, does it become like a briefing then at the beginning of the deal like hey guys, let's make sure we're then start recapping some of those lessons?

Yeah, yeah, we, we incorporate it, we can incorporate it into the kind of the early on presentation of the strategy that we're going to take for this business and how we're looking at the business and the role that it's, it's going to play as well. It serves also when you go to pitch it, the idea to the, to the executive team and the board that, that you've thought through this, you're learning from, from past experiences and you're not going to try to rep, you're not going to repeat those inadvertently simply because you've lost some, some institutional knowledge that you know, could have helped us. So we incorporated as well into, into our pitch documents and say, you know what, what can we learn about our past experiences that might apply to, to this deal? And I think that gives some assurance to, you know, the ultimate decision makers to say okay, they've, they've thought this team thought through this and, and you know, we're not going to trip over some of the same issues.

Questions? Yeah, I just kind of wrap things up. One of the thoughts too, when we talked about diligence, it's different than private equity. When a corporation approaches diligence, you're pulling in a lot of different functional leads. They're doing their part, looking into the company and figuring out the value. I'm curious to know how do you set that expectation? Because a lot of times people are busy, they're running a full time role and to be able to pull them in, the last thing they want to do is dig into another company that's going to be potentially acquired from your business. How do you actually get them to really do that, Set the expectations and sort of, I mean, I imagine the biggest challenge is just managing the details and making sure things are acted on.

Yeah, resourcing deal teams can be tricky. So we don't have a centralized team. We have a few people across our 35,000 person company. That do what I do and the rest. Everyone else on our teams have a full time job already and as you say, they're, they're not waiting around for me to come knocking on their door asking to give them some more work. However, that said, I also don't find it that difficult to get people interested in doing an acquisition. I think it's, it tends to be somewhat different from their daily work and it's a project based activity. So you know, it's, it's not, it's not the everyday same repetitive task maybe. So some people are very interested in taking on that new role. Maybe they've done it before, maybe they haven't, which add some additional interest to it. However, sometimes you run into a situation where they just don't have the time and they're already dealing with a lot. Everybody tries to maximize their use of resources or optimize their use of resources. So you're not keeping a lot of people around on the bench waiting for projects to do. So I think sometimes you do have to rescue aid situations. But for the most part we find that people want to participate. It's an interesting activity. It's confidential. Right. So they're not really able, you know, we have them sign NDA internal NDAs so they're not sharing information with. Not only externally certainly, but internally with their colleagues as well. And it's interesting, I think if someone's tagged for a work stream generally they feel like, okay, that's an endorsement that I'm an expert in my area. And so it's a bit of a, so it's a bit of a compliment as well to the interest of actually doing the project.

Is that when you keep them in the office late working banker hours?

Yeah. Our job's typically not a 9 to 5 type of role so we do ask a lot of our folks. But again you hope that they get a lot of professional satisfaction out of seeing a successful acquisition and integrated company company in the, in the future as we go down the line. So hopefully also there'll be a. I know there's a trend towards incentivizing deal teams but with a, you know, in different ways. So hopefully that'll catch on even more and it'll make it even easier to, to encourage people to join the teams.

Yeah, absolutely. That would be a great way with that. I think we didn't put a plug in for the conference but we're here live at the Global M and A network in Washington D.C. and want to thank you all for your time and Jeff, thanks for very much for taking the time with me today.

Thank you. My pleasure.

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