What should CEOs and Chairs expect to get from a management and organisation due diligence process?
Imagine the following scenario. As chief executive of a growth company, you have been working for months preparing a fund-raising process or sale to private equity. During the beauty parade of investors, almost all went out of their way to express their admiration for your business and even slipped in compliments for you and the team. They would be excited to partner with you for the next phase of your growth. Exclusivity has been agreed with the most promising party, and they then put forward their requests to get to completion. The financial and legal diligence was very much as expected: you know some things just need to be confirmed. Some commercial work was also anticipated and may identify new opportunities. Your advisers had given you a pretty accurate sense of what those workstreams were likely to involve.
Then management due diligence (hereafter ‘MDD’) is mentioned as a requirement. Why does that make you a bit uneasy? Was it because the investor seemed awkward saying it, like a kind of dirty secret after love-bombing you previously? Is it because details seem a bit hazy, and no one can quite explain what this is designed to achieve? You did once complete a psychometric to be told what colour or letters best represent you, and it was vaguely amusing, but how relevant would that be at this time of high seriousness? Might a couple of the team - who are anyway a bit nervous about the whole deal process and what it means for them – feel like this is too intrusive?
These concerns are legitimate. A decade ago, when I led a research project looking at the perceptions of 250 directors who had worked with private equity, many were underwhelmed by both the process and value of the overall due diligence process – e.g. only 20% of executives felt they received valuable insights from the due diligence process and fewer than half thought that they had been assessed by MDD adequately. Hopefully, those proportions have changed for the better in the meanwhile. However, the content, standards and benefits of MDD as an activity remain much less defined than other types of DD, so any improvement is likely to have been incremental rather than dramatic.
Starting from that sobering starting point, though, we think CEOs and Chairs should be both more demanding and hopeful. More demanding because by setting proper expectations for this area of DD, the chances of gaining benefit are higher. More hopeful, partly because structural trends mean that investors are paying more attention to management issues (see here for example). Secondly, the track record of MDD work carried out by Catalysis (across ~200 transactions) suggests that only a small minority of MDD processes (roughly between 1/15 or 1/20) reveal issues that raise question marks about the transaction. So, by implication, the large majority end up looking primarily at resolvable dilemmas and opportunities for improvement. Also, because, despite being a lighter (in time) and easier (in terms of effort) process than other DD workstreams, we have had plenty of feedback that many teams feel that MDD has ended up being the area of greatest value-add. Those points suggest two questions:
Where can value be created for CEOs and Chairs?
What requests could CEOs (and Chairs, if appointed pre-deal) make to gain more value?
Where can value be created for CEOs and Chairs?
For CEOs
The most apparent purpose of due diligence is that it provides sufficient comfort to investors to write a cheque to unlock the new funding structure. That is valuable to a CEO with ambitions to move their business forward. But there are various other forms by which they can benefit individually – as well as the wider team and business:
We have received comments from CEOs that the interview process itself can act as a form of coaching, even therapy, making sense of a whole career, for example, or offering insight into personal strengths and weaknesses, perhaps affirming hard-won successes. For leaders, exchanging views with a third-party regarding colleagues can help provide perspective and guide necessary decisions. For example, on a recent project, a CEO decided to remove two team members shortly after the interview: ideas that had been gathering for some time were crystallised. In other cases, insights may be reached regarding role boundaries or development needs. In one care home group, it became clear that the individual in charge of sales was great at maintaining client relationships but didn’t enjoy business development; a role split separated those things, helping retain a valued colleague and supporting growth.
An even richer vein of potential value can be mined if the MDD process looks not just at the senior individuals but at the overall team and organisational underpinnings of growth. Typically, it is easier to identify what strategic goals to pursue than to work through the intricate aspects of how to achieve them. So, determining the completeness of strategy – and especially its executability – can lead to breakthrough insights. For example, one software business knew it had an issue with its commercial structure but tended to over-complicate the solution (by looking for a design that was ‘right’ in principle) rather than taking pragmatic actions which would move in the right direction. A quick follow-up session post-MDD revealed a willing volunteer to develop the structure and some quick wins in terms of resourcing.
An MDD process can provide a starting point for scoping new roles and a framework for agreeing that with investors. Probably even more fundamental is to establish an open discussion with investors about which level of ambition is consistent with current and plausible organisational capabilities and capacity. Failing to do that is probably the single most significant cause of under-performance – with all its financial cost and human stress – as described here.
For many if not most CEOs of growth companies, there is precious little time to think about team and organisational effectiveness in any structured fashion. A decent MDD process can provide a rare opportunity to do so, informed with some data and outside opinions. For most organisational elements, there are few existing measures, so MDD analysis offers the possibility of making relatively invisible team and organisational phenomena become more visible. Catalysis believes that the purpose of any tool is mainly to provoke the right conversations around key questions rather than necessarily get the answers right: in that sense MDD outputs can be seen as a tool for the CEO to open discussions within their team which otherwise might remain unaddressed.
Since most CEOs of the companies we deal with have not had a professional Chair prior to investment, another angle for the MDD should be analysis and guidance on the right criteria for the Chair who investors will usually want to appoint with input from the management team.
For Chairs
Investors and CEOs often have high – perhaps unrealistic – expectations of what a Chair can contribute, and the hope is usually that they will add value very soon after appointment. So, for newly appointed Chairs, MDD should provide a shortcut to become familiar with what is usually the most critical challenge they face – understanding the team, what it is capable of and where it needs to be supported, and where challenged. Subsequently, MDD outputs should provide a foundation for decision-making around the ‘how’ of strategy across the post-deal planning period. Unlike, say, financial DD, where the bulk of the insight is clearly laid out in a report, with MDD, there is more to unpack through discussing strategic and organisational scenarios. That fact is what made the process of appointing a Chair for a manufacturing business in early 2021 so productive: several candidates were given an MDD briefing both to make them better aware of what the Chair role would entail - but also to draw insight from their reactions in order to identify the individual most likely to complement the CEO. The reality is that of all the DD workstreams, MDD is the one with the greatest potential for integrating insights from across the whole DD process due to its focus on future execution instead of analysing the as-is. That fits nicely with a Chair’s role of joining up market, offering, organisational and financial perspectives.
What requests could CEOs (and Chairs, if appointed pre-deal) make to gain more value?
None of the potential benefits outlined above are guaranteed. Some investors worry that, especially in competitive processes, talking about MDD might weaken their position. Others see MDD as an optional cost when deal budgets are under pressure. Yet others hold a historically accurate – but rather old fashioned and unambitious - view of MDD as purely a provider of commentary on team personalities.
In that context, CEOs (and less frequently Chairs) have the option to ask that the standard be set higher, namely that:
Management should be seen as the full set of people, processes and structures, through which strategies are delivered - rather than just a handful of people at the top of a business.
Consequently, key people from the second tier and other important team and business stakeholders should be touched by the MDD process.
The CEO expects valuable and actionable insights across the team, organisation and strategy from MDD - not just general commentary.
Apart from a report, interactive feedback should be arranged to support post-deal planning.
That approach demands more of everyone – but offers significantly greater value. It also places the CEO into the role of co-client and shaper of the due diligence process rather than as a passive receiver of requests. And proactivity is, of course, a good marker for future performance.
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