Due Diligence

Article two in the series of M&A with Impact - A practical mergers and acquisitions guide for general managers

October 2017

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The article was originally co-authored by Rickard Åkesson. 

Five M&A strategy considerations that have proven to increase the likelihood of successful M&A across industries over time.

Background and introduction

Acquisitions can significantly accelerate top line growth and often make the headlines, but the failure rate of M&A is extremely high – measured in net financial value creation. Extensive studies and research show failure rates for M&A deals ranging from 50%1 and up to as high as 90%2. In our own 2016 pan-Nordic M&A survey, respondents from across the Nordic M&A community – including business development, line management and private equity – rate only 62% of their own deals as successful. However, studies also show that companies that are actively engaged in M&A, i.e. frequent acquirers, on average over a multi-year period outperform inactive M&A companies, i.e. companies that do not make any deals, in terms of total shareholder return results generation3. This begs the question: What is it that the most successful acquirers do to achieve success?

Our guide is meant as a practical reference handbook on how to increase the likelihood of M&A success for business executives who may not already have significant M&A experience. In this introduction, we share tools, methods and insights that are tried and tested and have proven to increase the likelihood of M&A success over time. It is not our ambition to provide an exhaustive guide to how to manage all M&A situations, but focus is on the following three themes:

Article 1

Successful M&A strategies – outlining five M&A strategy considerations that have proven to increase the likelihood of successful M&A across industries over time.

Read article 1

Article 2

Due diligence success factors – focussed on practical tips and tools, including due diligence for
commercial, operational, supply chain, IT as well as leadership and team.

Article 3

Success factors for post-deal impact – outlining key considerations for impact post deal, which synergies have the highest success rates and the key to realising these synergies.

Read article 3

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Each theme is published as a separate article. This article focusses on the second theme: Due diligence success factors.

We share findings based on our experience from working on a large number of pre-deal and post-deal situations,  our latest 2016 pan-Nordic M&A survey and the recent M&A  with Impact event in Stockholm where 40+ senior M&A professionals shared their insights, tools and experience  with how to improve the odds of M&A success.

Due diligence – Understand what you are buying

Conducting a due diligence is essential to understand what you are buying and to establish a clear picture of the fundamental value of the business, i.e. what the main upsides and risks are. In summary, a due diligence gives us access to more information to:

  • Understand the target business, the market and the customers.
  • Identify strengths and weaknesses and the competitive position of the business.
  • Identify improvement opportunities (stand-alone).
  • Identify and understand key risks.
  • Identify possible synergies and how to run the company.
  • Prepare for successful negotiation and acquisition.

Due diligence may consist of commercial, operational, financial, legal, organisational (management) and environmental investigations etc., and there are many ways of doing these investigations – see examples below.

Examples of different types of due diligence

It is, however, the operational and commercial due diligence that mainly drive value through key components such as operating profitability (e.g. EBITDA), net working capital (NWC) and capital expenditure (e.g. CAPEX) and that subsequently impacts the company’s free cash flow (FCF) from operations and investments.

Example of a due diligence value driver tree

Below are some examples of reference commercial and operational due diligence checklists, which are not complete and exhaustive:

Examples of due diligence checklists – not exhaustive.

To begin with, it is important to ensure that the due diligence approach is driven by clear and defined hypotheses that can be broken down and tested. This should guide the focus of the due diligence process, including what questions to ask, and what market and company research and analyses to conduct. In fact, it is very important not to launch an all-encompassing market and company description review, but rather to link the due diligence strongly to the relevant deal thesis and hypothesis and focus on proving and uncovering relevant market and company attractiveness as well as risk factors rather than “boiling the ocean” in an unguided and unstructured way.

An example of a hypothesis-driven approach to test target value drivers.

In addition, a due diligence typically lasts only a few weeks, which is why it is vital to frontload work and draw up a due diligence work plan with weekly touchpoints across work streams to ensure good progress and alignment. An example is given below. Through focussed weekly sprints, the team aims to prove or disprove the hypothesis.

An example of a due diligence work plan with weekly touchpoints

The due diligence usually leads to an overview of the value and risks associated with the deal. To put a monetary value on the deal, there is also an action to value the company as well as the value of potential synergies and dis-synergies. There are many ways to value a company, and we will not go into detail about this, since much has already been written elsewhere about this, e.g. “Valuation”19.

In short, however, we can say that there are three ways that can be considered.

1) Book/asset value

1. This involves looking at the book value of possible assets being targeted.

2. Sometimes used as a proxy for value, but often does not reflect true market value.

3. Typically represents minimum value desired, and, if possible, make sure to sell above book asset value, or else a write-down loss will be required.

4. Most often used when the deal mainly involves buying tangible assets rather than buying operating business. Tangible assets may include factory machines, vehicles, buildings and/or land etc.

2) Net present value (NPV) of future cash flow

5. This involves projecting the future cash flow of the business being considered and estimating the current net present value of the cash flow.

6. This is a good way to establish the value of the business.

7. It is important to base the cash flow projection scenarios on a realistic forward-looking plan.

8. A very strong benefit of this tool is that it can be used to model and understand valuation sensitivities, e.g. what happens to perceived value if revenue or costs alter dramatically.

3) Market multiple comparisons (e.g. EBIT/enterprise value, sales/enterprise value etc.)

9. This involves estimating the market value of a business based on comparing the target business, e.g. sales, EBIT or other financial results, to comparable listed companies, and thereby estimating the likely market value of the target company – assuming that these companies are likely to be valued in a similar way.

10. If available, this is often used to give a top-down and quick understanding of the possible market-driven value ranges of a given company.

11. It is a very good complement to the NPV evaluation and is often used to calibrate and sense check the NPV.

12. Obviously, if used, it is important to ensure that relevant comparisons are being used.

4.1. Due diligence success factors

Our recent M&A with Impact panel discussion revealed the following key due diligence success factors20:

It is highly important to learn to sense trouble

Frequent acquirers outperform in M&A mainly because of their accumulated experience over time. It is important to pay attention to one’s own gut feeling.

Be aware of the “deal fever”

Many professionals fall into the trap of deal justification. It is important not to be naive or to overestimate the potential of each deal. A pre-analysis must be done well, and each deal should improve the company value.

Companies should be aware of their expertise

Companies should be aware of their position and where their key knowledge about acquisitions lie. Is the company’s main experience within a centralised or a decentralised organi­sational structure?

Management assessment is difficult during the pre-deal period

It is hard to assess the management potential during the pre-deal period, as access to management may be difficult and limited. Therefore, a good place to start is to assess their previous achievements.

4.2. Saving time

A due diligence is rightly thought of as an exercise involving several analyses. This is all good, but too often unnecessary analyses are performed. The key is to delimit analyses to test deal theses – and evolved deal theses. Also, a great deal of time and costs can be saved by starting analyses where the deal theses are weakest and/or can potentially be disproved with the least effort. Most deals have several deal breakers, and these should be analysed first. Yet, many due diligence processes start out by analysing market size, which is very rarely a deal breaker. Instead, starting out by looking at e.g. barriers to entry or competitor products in the pipeline coupled with customer needs analyses may disprove deal theses much faster, saving significant time and costs.

4.3. Due diligence examples

In this section, we introduce eight different examples of how to conduct a due diligence:

Due Diligence Examples

4.3.1. Market attractiveness

Market definition coupled with deal thesis

Before conducting a market analysis, be clear on what your target market is and which customers are included in that market (e.g. demographics, geography and products/services). Also be clear on segments in the market to capture differing growth rates and customer preferences in market segments, which in the very competitive deal environment of today is often key to finding worthwhile acquisitions.

Size and growth

Market analyses typically start with market sizing and growth. Coming up with an exact market sizing number can sometimes be difficult, which is why estimating if the market is “big enough” will suffice. While market size is important, growth is often considered more important – especially when the market is deemed “big enough”. Interestingly, back-of-the-envelope triangulation (doing several analyses of the same thing but from different perspectives) often yields more useful results than a massive in-depth analysis – see example below. 

Example of market sizing triangulation using different approaches to verify and estimate market sizing.

What is often important is to estimate the size and growth of specific market segments (i.e. applications, customer types, geography etc.). When it comes to estimating market growth, it may not be possible to have exact growth data. Here it is important to understand the market growth drivers and how they develop. Once customer preferences, growth, competition etc. in the market segments are known, it is possible to get an overview of how attractive it is to invest in specific market segments. Analyses of adjacent market segments to target segments can provide very important information on predicting competitor moves – e.g. declining margins in one segment can force competitors into the segment you are targeting and greatly impact attractiveness and thereby your deal thesis.

Value chain analysis

One of the most useful market analyses, particularly in B2B, is a value chain analysis. This analysis provides a good understanding all the way to the end customer, which can impact the whole value chain.

Understanding the customer’s customer will typically provide insight and uncover value opportunities or threats you cannot see by only looking at the direct customer. Furthermore, regulation or regulatory changes in one part of the value chain, e.g. production, can impact all parts of the value chain.

One example of this is when OEMs are restricted in the aftermarket (which has happened in some industries due to EU regulation) – this has ripple effects through the value chain.

Example of value chain mapping

Many of the topics typically included in a market analysis are covered below. Here are some examples of the most useful key questions to answer from the market part of due diligence:

  • What market segment is the target operating in (definition of core market)?
  • Is the market “big enough”?
  • What market share does the target have?
  • What is the overall market profitability?
  • How has the market developed historically?
  • What is the market growth segmented by price and volume changes?
  • What are the key market trends and drivers?
  • What is the projected market outlook?
  • Which market drivers will influence the company’s growth?
  • What are the key threats to sustained market development?
An example of a profitability (EBIT %) comparison. EBIT levels differ between individual peers as well as between Swedish peers vs international groups.

4.3.2. Competitors

A competitive analysis is a critical part of a due diligence process. With this evaluation, you can establish 
what makes the target’s product or service unique – to establish the target’s likelihood of succeeding with their profitable growth trajectory.

As for the market analysis, it is important to define who the main competitors are within the specific segment and the target’s differentiation and strength compared to those of the competitors. Based on customer needs, a number of competitive edge parameters can be listed, and a “gap analysis” can be conducted to define whether the gap is positive (competitive edge for target) or negative (competitive edge for competitor). The input for this gap analysis comes from interviewing the target’s customers.

If the current competitive landscape is not fierce, and the position is relatively strong, it is also key to evaluate possible barriers to entry into the market, thus establishing if the current situation is sustainable.

Examples of key questions regarding competitors
  • What does the competitive landscape look like (main competitors)?
  • What are the relative market shares in terms of revenue and volume?
  • What are the margins and growth of the main competitors?
  • What are the offerings of the main competitors?
  • What are the main points of differentiation between competitors?
  • How strong are the different competitors (competitive edge parameters)?
  • What are the product pipeline and strategic focus of the main competitors?
  • How are the target’s products priced compared to competing products?
  • What is the level of price competition between players?
  • What are the barriers to entry into the market?

4.3.3. Target’s customers

It is of great value to conduct customer due diligence in order to gain pro­prietary up-to-date customer
feed­back and point of view on the market and the target company. This allows the acquiring company to
identify aspects such as the current level of customer satisfaction and loyalty, customer purchasing criteria, volume demand, estimated time to market and so on. This drives needed actions to improve the customer ­experience, which is the most important value driver for most companies.

To determine primary market feedback and the strength of relationships with customers, the approach typically involves customer interviews, depending on number of countries and customer groups included.

The “focus group’s” approach can also be used with success. As a rule of thumb, a sample size of 30 interviews is normally considered sufficient for a normally distributed population, but smaller sizes could be acceptable in certain circumstances as well for a B2B business where the company does not have many customers. If the business targets many markets, then it is advised to obtain a sufficient sample size for each key market, e.g. if there are three key B2B markets then target up to 3x30=90 interviews, if relevant.

For B2C interviews, a much larger representative sample size is suggested, e.g. 300 or more interviews per market. Typically, this is conducted over several weeks (depending on scope and access) as a part of or a complement to the commercial due diligence process.

An example of net promoter score (NPS) country report Back-up: NPS country report: Germany.

Analyses and output examples include feedback on target company strengths and weaknesses and the Net Promoter Score21 (NPS), which allows scoring of customer relationships comparable to other companies’ relationship strengths.­

The NPS can be assessed on an overall level and split into countries, customer segments and/or product groups. Other analyses include an assessment of customers at risk, revenue at risk and margin contribution at risk,in total and by country, as well as an understanding of the reasons for churn, what competitor the customer left for, and what can be done to reduce churn - see figure above. It is also important to understand and verify customer purchasing criteria and the customer’s view on target and competitor value proposition advantages and disadvantages as well as the primary view on market growth and trends.

Examples of key questions for a customer due diligence
  • What are the customer’s key purchasing criteria?
  • What is the relative importance of each key purchasing criteria?
  • How do the target and key competitors perform on the customer’s key purchasing criteria?
  • What are the target’s strengths/weaknesses from a customer perspective?
  • What is the customer’s spend/bud­get outlook going forward?
  • Is there anything you are missing in today’s offerings?
  • How likely are customers to recommend target on an NPS scale from 1 to 10?
  • What is the level of repeat business?
  • What is the level of lost customers (churn) and reasons?
  • Who are possible customers at risk, and how many are they?
Examples of key questions for an R&D due diligence

4.3.4. Operations/R&D

When conducting a due diligence in R&D, it is crucial to explore the R&D function and gain an insight into how well the existing function is run, so as to better understand what the potential improvements are and to identify the key risks within R&D.

Maturity assessment (how)

First understand the overall maturity of the R&D operations. This typically includes site visits and in-depth interviews with R&D managers, analysing R&D material and data, including key R&D KPIs (e.g. innovation productivity,­ innovation intensity and innovation importance), undertaking a project portfolio and pipeline analysis as well as patent and licence research.

Improvement potential and key risks (what)

It is important to conduct an improvement lever and risk evaluation of the company. Potential improvements could include applying a Lean innovation process, increasing management focus on innovation as part of the core strategy, having cross-functional core teams and strengthening project management capabilities.

Potential risks could include the loss of talent and a cost down focus leading to reduced attention on R&D.

Synergy evaluation and PMI planning (where)

Next, it is important to evaluate syner­gies and prepare the post-merger integration (PMI) plans. Synergy evalua­tions can be carried out by holding synergy evaluation workshops with the company, if possible and allowed. Here, possible insights could be to co-develop products/services to increase revenue or adopt shared product platforms that result in cost reductions.

Examples of key questions for a sourcing due diligence

4.3.5. Operations/sourcing

When doing a due diligence in sourcing, it is important to understand the company’s procurement functions, procurement initiatives, procurement performance and its supplier management practices.

Maturity assessment (how)

First understand the overall maturity of the sourcing operations. This may include site visits, data extraction and in-depth interviews with the sourcing department. Additionally, a sourcing diagnostics review can be conducted through category profiling and supplier spend analyses.

Improvement potential and key risks (what)

It is important to conduct an improvement lever and risk evaluation of the company’s sourcing operations. Improvements may include supplier consolidation, supplier performance improvements, sourcing innovation, negotiation and contract performance improvements. Potential risks may include sourcing of scarce resources, bottleneck relations and supplier compliance.

Synergy evaluation and PMI planning (where)

Next, it is important to evaluate synergies and prepare the post-merger integration (PMI) plans. Examples of synergies come from economies of scale in conjunction with other portfolio companies in specific categories such as electric components and mechanical components. Typical synergies may also be increased through the utilisation of business know-how across categories as well as partnerships with strategic suppliers.

In the figure below, there is an example from a private equity owned portfolio company (industrial components) where 12 analyses per supplier and category were conducted to assess the improvement potential.

Sourcing potential analyses per supplier and category.

4.3.6. Operations/supply chain

When conducting a supply chain due diligence, it is crucial to gain insight into the productivity and performance, quality, best practices, footprint logic and other capabilities in terms of the company’s supply chain, taking into consideration the complexity of the products/services being produced/offered. There is also an ambition to understand whether functional and technological knowledge exist in the organisation which enable growth and minimise risk. In addition, it is often critical to understand the scale impact on production capacity and gross margin. Note that fixed gross margin in relation to volume is often a very
rough assumption that must be tested – potential growth might undermine profitability. Furthermore, it is important to evaluate the current production capital expenditure, e.g. understanding the thresholds that
trigger investments as well as understanding the cost of maintaining the current system etc.

Maturity assessment (how)

First understand the overall maturity of the supply chain operations. This may include site visits, data room performance data review and in-depth interviews with plant and operations managers. Also, this may involve conducting a scalability assessment of production capacity and gross margins and an evaluation of production capital expenditure.

Improvement potential and key risks (what)

It is important to conduct an improvement lever and risk evaluation of the company’s supply chain operations. Identifying potential, hidden improvement levers or risks is crucial since they can be deal breakers – e.g. missing approvals from authorities etc. – and, conversely, they can also offer an
important upside. Through a feasibility study of predefined and other improvement initiatives, potential improvements could include applying Lean principles to production, increasing focus on quality and scrap rates, high inventories and work-in-progress as well as internal logistics. Understanding the current
operating model will indicate whether the NWC level is right and potentially reveal system imbalances and lack of control in production/distribution. Potential risks include constraint expansion in current factories and lack of execution power in improvement initiatives.

Synergy evaluation and PMI planning (where)

Next, it is important to evaluate synergies and prepare the post-merger integration (PMI) plans. Operational synergies can often be achieved between factories/companies, if the specific products and product platforms­ share similar characteristics in terms of how they are produced, procured and even transported. The identification and assessment of operational synergies in collaboration with key resources and experts could point to cost reductions through factory consolidation and net working capital improvements as well as cost savings and risk reductions throughout the supply chain.

Examples of key questions for a supply chain due diligence
The current state and maturity assessment evaluates current operational and supply chain excellence.
Example of operational due diligence summary report

4.3.7. Operations/IT

When conducting an IT due diligence, it is important to understand the current state of technology used by the company. This should cover a capability overview highlighting dependencies and liabilities, potential investment needs, technology roadmap and the state of the master data.

Since IT due diligence is very often severely constrained in terms of time and access to acquisition target personnel, it is often beneficial to articulate a number of critical IT hypotheses to test early and then broaden the capability overview to extend coverage as time and resources permit.

Capability overview (how)

First understand the overall maturity of the digital supply chain operations. This may include conducting in-depth interviews with IT managers and key business stakeholders, validating the current state and roadmap of key IT systems (ERP, MRP, CRM) and an analysis of master data quality maturity in key IT systems (ERP, MRP, CRM).

Examples of key questions for an IT due diligence
Improvement potential and key risks (what)

It is important to conduct an improvement lever and risk evaluation of the company’s IT operations. Potential improvements are the standardisation and consolidation of IT service management, standardisation and consolidation of key IT systems usage and improvements in master data quality, enabling improved transparency and performance management. Potential risks are the unwanted
dependencies on individual IT resources (knowledge and experience), old unsupported versions and/or poorly maintained key IT systems, poor information security, lack of General Data Protection Regulation compliance and unfavourable IT supplier contracts.

Example of an IT due diligence summary report.
Synergy evaluation and PMI planning (where)

Next, it is important to evaluate synergies and prepare the post-merger integration (PMI) plans. Cost reductionsor efficiencies could come from common­ IT service management, common IT systems usage and common/­improved­ master data and from transitioning resource intensive services to cloud-based solutions.

4.3.8. Leadership team and organisation

A survey conducted by Grant Thornton comprising 135 private equity executives­ reveals that a strong management team­ was at the top of the list of important factors contributing to a successful portfolio investment22 - see the figure below.

Survey by Grant Thornton.

Correspondingly, due diligence in the leadership team and organisation is highly crucial given its strong influence on successful M&A with impact.

The purpose of organisational diagnostics is to X-ray the overall organisational efficiency, highlight where best practice exists as well as issues and why, measure management teamwork efficiency, test the management team and key functional capabilities and map the organisational culture (current and desired). Organisational diagnostics are typically made based on interviews, observations, surveys, workshops and focus groups. There are many organisational surveys that can be conducted.

The figure below shows some examples.

Organisational diagnostics survey examples – when access to management and organisation is possible.

Note that often these diagnostics tools are not possible to use in a due diligence situation, as access to management and the organisation is limited and maybe not even possible at all. When this is the case, it is
advisable to try to make an “external” assessment of the management and key team capabilities. This can be done by investigating publicly available information on the key people, e.g. using LinkedIn (where you can typically find education, time working at the company, function and other information), Facebook and a review of references in public media. While an external search will not provide the full picture, it may help provide some additional useful insights into the target company in question.

Example of external sales force strength assessment


1. Sher, Robert (19 March 2012). Why Half of All M&A Deals Fail, and What You Can Do About It. Forbes

2. Christensen, Clayton M., Alton, Richard, Rising, Curtis & Waldeck, Andrew (March 2011). The Big Idea: The New M&A Playbook. Harvard Business Review

3. Harding, David & Rovit, Sam (2004). Mastering the Merger: Four Critical Decisions That Make or Break the Deal. Harvard Business Press

19. Valuation: Measuring and Managing the Value of Companies, Tim Koller, Marc Goedhart, David Wessels, McKinsey & Company Inc.

20. Panel included: Peter Nilsson, Senior Industrial Advisor to EQT and former CEO of Sanitec; Conny Karlsson, Partner at CapMan; Jan Dahlqvist, Partner at Polaris; Mikael Norlander, Senior Investment Manager at Ratos; Henrik Åstrom, Group Finance Director, Head of Treasury and M&A at Fagerhult

21. The One Number You Need to Grow by Frederick F. Reichheld. From the December 2003 issue of Harvard Business Review

22. Grant Thornton (2013). What can be done in 100 days?