Insights & Reports > Business Intelligence: Don’t fly blind

Now is the time for all good men...to read the fine print. Out of all those deals done when the economy was hot and time was short, many are now looking somewhat pale, perhaps even decidedly sickly. The natural and sensible inclination is to decide whom and what to blame. Natural, because that is human nature; sensible, because understanding what happened, and how, will help address the problems and perhaps provide some basis for relief.

Not so long ago, you could rely on the “greater fool” principle for relief: however stupid you may have felt for buying the company at that price, there was bound to be a greater fool out there to whom you could sell it. While stupidity probably still lingers, the greater fool can no longer find the financing to pay for new misadventures: according to Mergermarket figures, the value of European private equity exits, for example, is down 91% for Q1 2009 versus Q1 2007 [see graph]. So it is ever more likely that, when a deal goes wrong, you will be the one stuck with cleaning up the mess.

Increasingly, Kroll’s clients have been coming to us suffering from varieties of buyer’s remorse. Sometimes the business simply is not performing as promised (but then, which company is?); sometimes it is not quite the business that had been described by the seller; and sometimes it came with some very undesirable surprises – corrupt relationships with clients, undisclosed contracts or disputes, management self-dealing, or environmental time bombs.

Here is where the small print comes in: the reps and warranties, the rescission clauses and the claw backs that you may have felt your lawyer was drafting just to bump up his billable hours, suddenly all seem worthwhile.

One private equity client was backing a roll up strategy in Europe. The original acquisition was good, completed after proper, hands-on due diligence by the fund. The problem came with one of the add-ons, where the acquisition was led by the portfolio company management – good technologists but not so experienced in acquisitions. Key contracts of the purchased company turned out to be in dispute and close to termination, various services were contracted out to related parties to the seller on non-competitive terms – the more the client’s executives looked, the worse it got. We helped them to get a handle on how extensive the problems were; to wrest control of the business from the seller, who was still in situ; and to define precisely the degree of misrepresentation involved (was it fraud or just excessive gilding of the lily?).

We then assisted in preparation for negotiations – with an appropriate threat of litigation as an alternative – to remove the seller as director of the roll up entity, cancel the back end of the purchase price, and even take back some of the front equity in the deal.

Another recent case involved a listed, multinational, heavy machinery company which had bought a private business with good, complementary market coverage, only to find that operations in one crucial national market were entirely corrupt. All of the key client relationships there were secured through bribery. The purchase due diligence had thrown up some indication of this, but the seller had claimed to have cleaned up the business through putting in place proper contracts and financial structures that prevented further abuses. New structures had indeed been instituted, but only to hide the fact that nothing at all had changed. Helping to document and specify this gave the client ammunition to make a nine figure recovery from the sellers.

I could go on, but it doesn’t get any better. The important point is that when the deal sours, you do not necessarily have to put up with it. Post-transaction due diligence may seem like post-event stable door shutting, but when there are still horses present, that is a good idea. Obviously, as the owner rather than the buyer – or worse, the bidder in an auction – you have far more access and control. This implies some very different approaches to due diligence, requiring different skill sets. Sharp-eyed forensic accountants will get more from the numbers than even the best transaction team. Better still is to support the former with a team experienced in data mining – a technique to expose patterns of fraud and abuse in very large volumes of accounting data. Interviewing key staff, customers, suppliers and even regulators – call it a “compliance audit” – will tell you things you really do need to know. It is shocking how often we hear, “I wondered when someone was going to ask me about that” or “I wanted to say something, but I wasn’t sure who to tell.”

The exercise may require different people as well as different skill sets from the original due diligence. If things have gone very wrong, the advisers who helped put together the deal may not be the right ones to perform the post hoc review. At the very least, they will want to come out smelling like roses. At worst, they may be sharing the blame and perhaps carrying some of the financial consequences.

But spare a kind thought for the lawyer who drafted the dull but critical fine print. Next time you see him, say “thank you,” assuming, that is, you did not let the seller delete those paragraphs.

Summary	In the current economic climate, numerous deals that looked good during better times have turned sour. Post-transaction due diligence, which requires different skills sets from that which takes place before a deal, can reveal information a company might use to claw back money put into an unfortunate purchase.
Time frame to complete	Within 4 weeks you will understand whether a full assessment is cost effective.
Cost considerations	An initial review will cost between 15,000 to 75,000 of the local currency.
Advantages	Mitigating and limiting losses from an unsuccessful acquisition.
Risks	None.

---

Tommy Helsby is Chairman, EMEA based in London and can be contacted on +44 20 7029 5000 or .