How to Structure Teams Approaching M&A Diligence

‍Text Version of the Interview

Difference Between your Previous and Current Role

I was effectively running two shops out of Aon. There was a team in Chicago and a team in London. 13 resources in total, with about three deal leads, a couple of analysts, and many project managers. But in Cetera, there are about four people. And I have one project leader, one deal lead, and two senior analysts.

They are extremely capable of running the team by themselves, but the issue was simply scaling the team to accommodate more volume. And a lot of that I'm doing through process change, as opposed to adding resources at the moment. 

The team engaged in the transaction is relatively small and did a lot of the integration planning phase. And one of the things that were holding them back from accommodating greater deal flow was the amount of diligence they were doing in the pre LOI phase. They wanted a perfect blueprint on precisely what would happen before they would even proceed with a letter of intent. 

One of the changes I made pretty quickly was making some assumptions based on historical experience and getting the LOI in place as fast as possible. Getting that exclusivity period is valuable to turn this into a bilateral instead of allowing them to continue to shop. 

Once you get more comfortable with risk, sign the LOI, and figure it out in diligence when you're engaging more functional experts. 

So the deal volume has picked up, and I haven't added anybody to the team yet. 

Private vs. Public Companies

Generally, you're optimizing for the long term. But there's a lot of pressure in public companies to cause you to optimize in some instances for short-term outcomes that may not be in the best long-term interest of the business.

It's much easier to make longer-term investments when you no longer have those quarterly obligations, which is super helpful. And not having that pressure frees you up to do more value-added things as well. 

There are also a lot fewer reporting requirements in a private company. There are just fewer people that are engaged in the decision-making process. 

So you get to know those people, understand their risk appetite and what type of transactions they'll support, and life becomes a lot easier in terms of just engaging and moving transactions quickly.

The other thing that can't be underestimated is taking risk and price risk more appropriately. In a large public company, you get specific functional stakeholders who are maybe more risk-averse than others.

With a sponsor-backed company, you can more properly evaluate that risk and wear it if needed or transfer it to a third party more effectively. So you're willing to take on that tail liability that may be attached to.

The last piece is that you are more impactful when M&A is critical to a sponsor's growth plans. If they need to grow, and you run corporate development, you're a key player now. So they care a lot about you and the volume that you're bringing and the impact that you're having.

Coming from the Navy 

You wouldn't think it would be applicable, but one of the things that I learned very quickly is that winging doesn't cut it. They like processes. They like you to start up the reactor according to the manual. 

And when things go wrong, they want you to execute the procedure they've outlined point by point; you don't get the adlib. So you develop a pretty good appreciation and respect for the power of process.

Also, you can't write a procedure for every potential scenario that you face. So while they do outline a lot of the processes, they also give you some freedom to adapt that process to unforeseen circumstances. 

So from a deal context, you understand that having a good process is critical to a good outcome. It also becomes the mechanism by which your organization learns. It learns from failure; it's the way you incorporate lessons learned. 

And you also understand that while a rigid process can serve you well, you also need to be flexible enough to adapt that process to every deal because every deal is unique.

Every integration is a little unique. So you need to be flexible enough, but definitely need to understand that the process is your friend, and you need to embrace them. 

Organizational Learning

There are lots of different aspects to this. One is we all make mistakes. We're never going to be perfect in what we do. And you need to understand that every transaction has more downside risk than potential upside.

So you need to be thoughtful about how you go about diligence and every other phase of the transaction. The process that you put in place that you are executing should have fairly defined elements to it.

But even if you've got a strong process, if you're executing it kind of differently per the whims of the deal leads that you've got, you're opening yourself up to making the same mistakes you've made in the past.

The process is there and it's been based on and built upon from the mistakes you've made in the past, and you tweak it each time. The process is super important in making sure that we don't make the same mistakes again. 

The next question is, how do you make sure that you learn from that and you make the most of that process when you're executing? And that's through the project managers. The project managers make sure that the deal leads execute the process according to how it's designed.

And when we deviate from that process, it's with good intention and an overt decision, as opposed to just a whimsical one. You need to be thoughtful about them and understand the exposure you're taking on when you deviate from the process. 

Another way to improve the process is through the feedback when you do the post-close reviews. Open polling of the participants in the due diligence and integration process on what went right and wrong. Capturing those learnings and then making sure that the process adapts to accommodate those learnings. 

Project Manager

These are project management professionals. They're generally people who have managed integrations that are steeped in the operations of your business. 

They usually come from IT simply because they are tasked with IT projects if your organization has a project management organization. So that is a potential source. 

Generally, I find the IT PMs don't do well in their role and need to be more broadly based. They need to have broader exposure to the other functional areas of the organization. 

And if you're fortunate enough to find people who have managed integration work in the past, they're best suited for these types of roles. Heavy operations experience. These are people who get stuff done. 

And then what you do is you bring them into the diligence piece, and you teach them the diligence aspects and how a diligence process is run. 

And then they run that piece as well, as you shift ideally out of diligence into contracting, the diligence team then shifts into the pre-integration planning phase, and they continue to manage that aspect while the Corp dev and legal teams get to work on the contracting piece. 

And a lot of those people are outsourced already. So if you've managed large scale integrations before you'll hire externally for some kind of flex capacity, whether it's one of the big four, some of the other consulting shops that provide project management resources or our post merger integration support.

Those people that have some tenure in those organizations would fill that role really well. 

Other Key Functions Aside from PM

It depends on the volume of deals and on your organization's ability to staff or invest in the function. But the areas where you see the greatest complexity, if you're doing professional services, is going to be around IT and HR.

Adding resources that are specific to those functional areas that speak M&A can be very, very helpful. Whether they're hard-lined into the Corp dev team or dotted line doesn't matter so much as they are dedicated to M&A. 

And this is also another key element for capturing corporate lessons learned and leveraging them for the next deal.

So HR professionals, HR ops, there are so many aspects of HR that are really complex. And you're always asking to break systems because bulk onboarding a bunch of people coming over from another company is just not how HR systems are generally built.

You need solutions that you don't want to be reinventing the wheel every time with the transaction. So having a professional on the HR side who has seen a lot of deal volume is super valuable. You don't want to lose them after each transaction and bring up somebody new.

So the other area is also IT, which has the exact same issues. A ton of complexity and navigating the organization can be very difficult. 

Having one person who works in deal time, has seen many transactions that understand how we break systems, understands the assumption about their machines and can foresee things that could go wrong in their equipment, is truly valuable. So you're not re-learning them every deal. 

Those are pretty much; I would almost guarantee that those are common, and I hear them across panels; everybody agrees when I sit on panels and talk to people who work in other industries. Those are the things that matter to all of us. 

And then other areas also matter, depending on your industry. And in my world, conversions, getting assets converted off of one platform to another is a big area of complexity.

So making sure that you've got resources that have seen transactions that can speak to that expertise is important. If you're in tech, there are other equally painful areas that you need to have specialized resources for. 

The way across all of that, how you organize yourself is honestly, I think a little less critical. I think I felt differently about that before, but if you're a functional team, a healthy team, and you've got good, strong leadership, whether those people dotted or solid line into you, don't care. They're there to help you solve problems.

And if you lead them properly, the team will be healthy and functional. 

What about Legal Team?

There always has to be an in-house counsel that has transaction experience on staff. And they're your partner; they're your closest function within the organization. 

We are joined at the hip, and as long as you're a team, and you work collaboratively together, you test each other, you push each other, and you are humble enough to understand that you need them as much as they need you, you're going to work well together and you're going to be very successful. 

You always need external counsel just for the arm and legs piece of it. Somebody who's very current and understands what the market is. 

But having in-house counsel that understands your risk framework and how your organization wears risk and can think collaboratively with you on solutions for mitigating risks that are uncovered in the diligence process is really helpful. 

And that is critical and you don't need a high volume shop to justify that. These are probably people who are wearing other hats in low volume companies, whether they're the corporate secretary or just the corporate attorney in general.

You've got somebody who has deal experience as a transactional attorney in addition to general counsel, who in our world almost always is an ex-litigator. 

M&A Process

From a structural perspective, my team is divided up into three components. I've got resources deployed on sourcing, got resources that are deployed on transaction execution, and then resources deployed on integration. 

If you're going to be doing a lot of deals, then I think having source dedicated sourcing resources is critical. 

Those folks are looking a lot more like sales teams, and they have comp plans that look a lot more like a sales comp plan where they're rewarded for getting transactions closed or introducing and then paid on transactions that close. 

The deal team is a bunch of investment bankers—Ex investment bankers and analysts who are very experienced in getting transactions over the line. And then my integration leads we've already talked about. 

For a typical deal, we'll get engaged in the sourcing timeline when my team has either reached out or somebody reached out to my sourcing lead and wants to have a conversation.

So we get engaged, talk to them about their objectives and how we might find a middle ground; that's a good outcome for both of us. 

If we get to the point where it's worth exploring, we will get the NDA in place; my deal leads will then get engaged and collect the data from the other side. From there, we'll build an evaluation model based upon some of the assumptions around how we think this thing would ultimately fold in. 

If you notice, I'm trying to rely on the expertise of the team. I am not engaging the organization broadly yet, because they've got a day job, and they're working on some pretty critical things that I don't want to disrupt at the moment.

So I'd like to leverage the expertise of my team, both the integration team and the deal execution team, to build an initial hypothesis around how the other business would fold in. We socialize with my boss and the finance team and make sure that everybody's signed off on it.

And then, we present pricing. If the pricing is acceptable, we'll put it in a non-binding letter of intent. Letters of intent are always helpful, so everybody understands what was agreed at the time because memories kind of fade, and what was agreed sometimes get re-threaded.

What isn't helpful is negotiating a SPA and a letter of intent. Assuming we're in a bilateral deal, a letter of intent will cover a basic transaction structure, strategic rationale for the transaction, and then the cost or value of the organization.

And in the wealth management space, which is a little unique, we need to talk about transition assistance for the advisors associated with the other broker-dealer and what type of assistance we'll be willing to provide to them for the conversion process. 

Then it's a standard process. The seller will open up a data room, and assuming that everything's inked, we'll go through a diligence process. Diligence generally takes four to six weeks, assuming we got a cooperative seller that's fully advised and knows how to manage a data room. 

After the diligence phase, we're going to shift into contracting and integration planning. Generally, that takes about four to six weeks. That's when the Corp dev team gets even more engaged and works hand in hand with the legal team to get the contracting piece done.

It takes that long because there's a pretty significant scheduling burden attached to all of these deals. It just takes a while to get through all that.

You're going to make a bunch of reps and warranties around how the businesses operated but there will be exceptions to that. And when you have exceptions, you're going to detail them out, and you're going to schedule them. 

And those schedules need to be reviewed. It's also a diligence problem because if you promise that the business is operated X and it turns out is actually X except for the following items and you find that those items that they're taking exception to are material, maybe that poses an additional risk that you need to wear. 

Maybe you need to mitigate that. Maybe it's a price chip, it might open up the negotiations, and you might have to adjust the terms that have been agreed now. 

Unfortunately, these schedules always come out after the contract is pretty much been is close to the final form. So people are tense and exhausted. Sellers don't want to negotiate anymore. 

And that's one of the areas where I think a lot of mistakes are made is at the end, when you're doing the schedule reviews and the final terms of the document.

Closing

Now we're signed. If it's a sign and close, you could be close. But sign and close don't happen that often. Almost always, some pre-closing conditions need to be satisfied. Sometimes it's regulatory approval; sometimes it's consent.

Suppose you've got a highly regulated industry, like the wealth management industry. In that case, your entire integration takes place during the pre-closed period, because the whole process of closing is the conversion process - moving assets from one platform to another. 

A great deal of planning and coordination has to go into so that there's little to no impact to the actual investors that own those assets. 

It's a highly regulated process that can take up to four to six months to get that. So you can have a very long pre-close period. You can have a very short or no pre-close period. It depends on the circumstances of the deal.

I think what people fail to appreciate is that the longer the pre-close period, the more risk you're wearing. There will be an impact on the business, and you have very little recourse, even though you try to contract it with operating covenants on how they're going to operate the business.

The reality is if there's a material degradation in the business, you need to renegotiate and change the deal to accommodate the change in the business, and you don't want that. It's called the material adverse event.

These really big events have a material change in the business that occurred during the pre-close period. It's like a comet strike-like event. It's so high that in the state of Delaware, one MAE event has been certified or been worked its way through the court system like a true MAE. 

But many events, many contracts have been renegotiated due to events that could be construed as an MAE. So purchase agreements have been modified more than once to accommodate significant events that have occurred that could have potentially been MAE.

The longer the pre-close period, the greater the risk to the buyer, you're obligated and you are incentivized to try to minimize that period, and the shorter you make the period, the better. 

The sellers are also incentivized. They want their money as fast as possible. So they're going to ask you to bear as much risk as possible. 

In a standard deal, only two things would cause the closing to not occur at signing, which is regulatory approval from the business. You have to wait until the government or the regulator party tells you that it's okay for you to own that business. 

The other is consent. If a contract that the entity owns has a change of control provision in it, you're obligated to get consent from the counterparty that it's okay for you to step into their shoes and not blow up the contract. 

Now, that is where there's a lot of questions about the amount of risk you want to bear. Because if it's a vendor contract and you're more creditworthy than the previous buyer, they're not likely to throw any water on the situation. So do I need to wait until I get consent from every one of those vendors? Probably not. 

Landlords are a classic example. One time, I was forced by the seller and adamantly required us to go get consent from every landlord they had. And it was the worst mistake I've ever made. 

On the flip side, you've got some contracts that are material, like partnership contracts with the largest clients of the company that you're acquiring. You want to make sure that they're along for the ride and they're comfortable with this transaction. 

Integration

After the deal is closed, everyone is fairly happy and celebrating. But the reality is, you haven't created any value yet with the shareholders. You've merely set the stage for value creation. True value creation occurs in the integration when you actually execute. 

You've got a good plan, but the reality is you don't truly understand exactly the situation and some variables will change. You will have new data that comes to light that you didn't know was material before, but it turns out that it actually is material. So you need to be able to adapt. 

At the same time, you need good governance, just like you had during the diligence and contracting phases. You need a strong governance process during the integration phase. You need a war room and a process around a steering committee.

Having a steering committee and an executive sponsor is probably the most important thing. The job of the steering committee is to ensure that the integration is executed according to the business case originally authorized by the board or the shareholders.

Any deviations from that are prudent. You will need to make changes, but everyone needs to approve it before you can do it. 

The other key item is an executive sponsor. The proverbial throat to choke on the integration. Somebody has to be passionate own it, champion it. They, they got to wear it. 

In my previous life, more often than not, it was the country manager. Whoever was running the country was the most important person in that country. At Cetera, we still have champions that own the integration, but the steering committee represents all the key functional areas with the senior leaders present.

If we have multiple transactions going, we have one solid block of time for the steering committee every week that goes through all in-flight transactions. And it's fairly regimented so that we make the best use of the executive times participating in the steer-co.

Integration Management Office

We got a PMO team, but they're primarily around the strategic projects and are more IT-focused. I have a dedicated integration resource, and she knows the integration better than anybody we know. 

She is just deeply steep in the operations of the business, and she's a certified PM. She knows exactly what she's doing, and more importantly, she scales. So I can throw temporary resources underneath her, and she can manage them to accomplish the integrations because she knows how to structure the teams and make sure the right folks are addressing the right problems. 

When do you Involve integration?

Not prior to LOI, but immediately. They are aware of the deal, but they are not engaged. I've got a weekly staff meeting covering the pipeline, and the integration team is present for that.

But as soon as the LOI is signed, then they are engaged. And then the same team that is ultimately going to manage the integration is engaged way upfront when we start building the diligence plan, staffing the diligence teams, and ultimately building that pre-integration plan. 

I only engage the legal team pre LOI. If you're looking at many deals, you're trying to minimize the impact on the organization of transactions that are unlikely to close. And every deal pre LOI is unlikely to close. 

So I don't want to impact the organization, and I want to keep them out of it until we get something that's probable. And if you can find agreement around value, then it is probable.

So keeping the organization shielded from the pre-LOI activity is pretty imperative to making sure that you're making the best use of everybody else's time. 

Proprietary Deals vs. Banker Deals

Fortunately, the majority of our deals are proprietary. They're bilateral. 

The biggest risk of any transaction is culture. Culture eats strategy for breakfast. Even the most strategic deal on the planet, it's dead if you've got a cultural mismatch. It's just not going to work. 

But if you're in a bilateral, you get a lot of time with the other side. It helps you assess culture. 

If you're running an auction process and this is kind of the first time you're meeting them, you get a management presentation for four hours and then maybe a couple of one-on-ones and a few other potential discussions. It's just not enough. 

At Aon, we built a tool to assess culture. Through the diligence process, you're likely engaging with a lot of different one-on-ones in different interactions with different people through the organization. And there are other artifacts that you're requesting that speak to culture:

• Employee handbook
• How do they make decisions? 
• What their benefit plan looks like? 
• How do they promote hiring practices? 
• How do they make strategic decisions?
• When you're talking to their CTO, what decision-making authority do they have? 
• How do they plan? 
• How do they make decisions? 

So you are gathering a whole bunch of data that applies to the culture. What you need to do, though, is just collect that data, evaluate it with an eye towards culture.

And we execute the tool that we developed on the target, and also on ourselves. We are then able to identify the areas where friction is likely to arise. Be sensitive to it and build the integration plan with that knowledge. 

If you see cultural conflict, good economics isn't going to overcome that.