Gregory Cessna has been on both sides of the deal table. He’s run companies for venture capital, managed public companies, and been a part of four businesses that were sold where he stayed on with the new owners for four or five years.
However, he’s found the work that’s done before the deal paperwork is signed is often the most critical.
“In the due diligence process, often the post-acquisition synergies are lost,” Cessna says. “Most people think those synergies are started at the close of the deal. I actually think they have to start in advance of closing.”
The CEO of Pittsburgh produce distribution business Consumer Fresh Produce who also leads a scientific instrument business and a consulting company, Cessna shared best practices for acquisition due diligence at the 2019 ASPIRE Dealmakers conference earlier this year.
What are some critical components to the acquisition due diligence?
In my experience, executives that are selling to either a corporate buyer or a venture capitalist are gifted at selling. They’re usually strong personalities and high energy. They’re built a business and they’re convincing you of its value.
You need to confirm that value goes beyond the leadership. The DNA of the company is how things get done, how they handle challenges, how they handle success, what turnover rates exist, who are the key people. The due diligence periods, more and more, are getting shorter. It makes it difficult to climb underneath the leadership.
My advice would be to consider that they are, first and foremost, trying to get a transaction in close. If you take their input, often you learn different things after the transaction closes.
The second thing is to understand that past practice is an outstanding representation of culture. How did they handle slowdowns in the business? We have a great example now where we can look at ’07, ’08, ’09, when things were challenging economically. How did they handle that? Did they stay with their people? Did they build a culture of retention? Did their best people leave?
Everybody handles success pretty well, but you can learn a lot about a company by simply asking how they handled economic challenges in the past or how they handled leverage when their bank covenants were in threat.
The most important discussion, though, is a pre-deal discussion with the founders, which often gets avoided because it’s a tough discussion. What’s their reason for the exit strategy? Do they still have a passion and a drive to execute in a business?
You can look for clues. When they talk to you about why they’re selling and it’s about their life, that to me is a red flag. When they talk about why they’re selling and it’s about what the business’s needs — maybe the business has great products, but it doesn’t have the distribution in channel that it needs, or it needs more IP investment or capital investment in bricks and mortar to expand — that’s a really good sign.
Do you prefer making management changes that are necessary and inevitable before or after the acquisition?
The assessment needs to be pre-acquisition. That discussion, while difficult, is important. Generally, if the seller knows that, they’re open to a dialogue that says, ‘Let me help you make the transition.’
You have to measure the behavior of that dialogue, not necessarily what’s said. When someone gets a big check, it changes their attitude about work. If they don’t have that inward, burning passion for the business, the desire to take it to the next level, I believe you’re smart to almost immediately bring in a second in command with the intention that they’re going to make a transition in 90 days, or worse case, six months.
I promise you it’s not a year, because the organization sits there and says, ‘Brian’s done. He’s got his money. He’s done. He’s just putting his time and he has a one-year contract.’ That dialogue happens. The company goes into a mode where they’re not sure who’s in charge, but they know it isn’t Brian any longer.
So, bring a strong second in; I’m not talking about a CFO, but a strong operator. In the event things go faster than you anticipated, you have somebody ready to step in. Let them take control of the business and lead it, because people more than anything else want to know where you’re going, not where you been.
How can third-party expertise help assess changes that need to be made?
It’s a good idea to bring in third-party expertise, especially if the deal is a smaller company, say under $50 million. They tend to be myopic. They have a high opinion of what they do and how they do it, but they tend not to have clarity around what their true value proposition is and the threats to the business owner because they’re opportunistic and they tend to be niche-y.
If you can bring a third party in who understands the industry, often, they find value in that business that’s untapped. It’s unrealized or it’s not recognized because they’re so focused on where they’ve had success, that they see past success as defining their future state.
When you bring in somebody who has a broader view of the industry, they often see past that and they may even say, ‘Hey, that’s running its course, but this technology or this product has an opportunity to compete effectively in these emerging opportunities, which will drive growth.’