ROBSON LEE: Beyond bare legal and financial due diligence in M&As

COMPANIES, especially those with a growing pile of cash, usually are on the prowl to acquire businesses.

Hungry acquirers can be won over by reports of pretty past profits of the target businesses and by forecasts of even higher profits.

Sure, acquirers do due diligence -- but they would be making a big mistake if they overlook some key matters that go beyond the impressive financial figures.

NextInsight photo ”I have done due diligence for some clients where I have advised them to walk away from potential acquisitions that looked attractive and compelling.  For example, in Singapore, there was a case where we felt that some of our questions were evaded, the CEO acted blur and so on. Something didn’t seem right, and true enough, some time later, we learnt that he was under investigation for falsifying accounts.” -- Robson Lee (photo)

As Robson Lee, a partner at Gibson, Dunn & Crutcher LLP, says: "The legal due diligence we would advise our clients to make is not so much whether documents are in place, whether the target company has the relevant licences,  whether the profit & loss statements are in accordance with international accounting standards.

"They should also look at the people who make the numbers so attractive and compelling.  Find out their modus operandi, their company culture, the ethos of the people who form the core management team and sales team. If necessary, talk to their customers," says Mr Lee in an interview with NextInsight.

With in-depth probing, a deal can lose its allure considerably. "If something rings a little bell of alarm, such as 'I set aside about 3% of sales to make people happy, add a bit of lubricant', ask yourself if the financial numbers are sustainable when a set of rules which your company upholds are applied to them. 

"Are some of their practices in contravention of anti-bribery, anti-corruption laws? Is there any possibility of lax internal controls and risk management such that one day you may get a rude shock like what you read about regarding BSI?"

Beyond a company's culture and how its key people carry out business, potential acquirers should also take cognisance of certain laws of countries such as the US and UK which, for example, forbids dealings with nations such as North Korea. There are laws that target money laundering, drug money, etc.

Inadequate due diligence, which can lead to "fatal and final" consequences, as Mr Lee puts it,  is not uncommon among businesses making their maiden M&A deals, as well as large corporations which are more seasoned in this aspect.

After all, managements have certain innate tendencies. 

"CEOs and CFOs invariably look at KPIs -- these are basically numbers. A deal that can improve their bottomline by, say, 30-40% would certainly look compelling. There's a good chance they will believe that no major problem would happen on their watch.

"What if it does --- just as you are about to retire, or move on to the next appointment or employer? Unfortunately, if a major corruption, for example, is discovered, then this problem is now part of your group, and you can't divorce it away." 

And it's not just CEOs and CFOs who should be doing due diligence. An "integrating team" should be involved too.

The latter is vital in assessing the chances of achieving success in integrating their companies with that of the target acquisitions.

"There have been many cases of M&As that failed (as reflected in an exodus of staff and a collapse of business performance) because the integration process was not successful, there was no re-alignment of values and methods," notes Mr Lee.

"You can expect that there would be people differences, political differences, cultural differences, especially in cross-border acquisitions. If a Singapore company buys, or invests into, a Chinese or Vietnamese or Myanmar company, you can imagine the gulf of differences and mindsets. Thus, reconciliation and alignment of values and methodologies are a very important aspect of M&A." 

Robson Lee is also a member of the Appeals Advisory Panel that advises the Minister-in-charge of the Monetary Authority of Singapore in respect of all appeals on matters that come under the financial and securities laws and regulations of Singapore. NextInsight photo ”CEOs and CFOs invariably look at KPIs -- these are basically numbers. A deal that can improve the bottomline by, say, 30-40%, would certainly look compelling. There's a good chance they will believe that no major problem would happen on their watch.  "What if it does -- just as you are about to retire, or move on to the next appointment or employer? Unfortunately, if a major corruption, for example, is discovered, then this problem is now part of your group, and you can't divorce it away."  -- Robson Lee (photo)

Even before taking the M&A route, companies should lay down policies and rules for their staff on what's doable, what's not acceptable, etc, says Mr Lee.

These covers areas such as entertainment, gifts, etc.

To ensure that rules get followed, there should be a risk management team working with the financial controller, since it is the latter who will receive the expenses claims.

"All this is to ensure consistency wherever you operate. It's like MacDonald's  -- the uniform is the same, the mascot is the same, the way signboard is placed is the same."

One last tip from Mr Lee: A company should stay clear of doing deals with those from a different industry.

Since its management does not have any special insights into, say, mining, a construction company should not buy a mining company, for example.

Yet such marriages have happened for many reasons, including the acquiring CEOs being overly optimistic about the outcome, or they are wired for extreme risk.

And you can be sure that they were likely not adequately advised by professionals.