Covid and Cultural Due Diligence in M&A          

There’s reason to believe that M&A will rebound in 2021, according to Ernst & Young research.[1] Nevertheless, the multifarious challenges created by the Covid-19 pandemic have significantly altered the climate for acquisitions.[2] Even in normal times, getting a deal to close does not guarantee long-term success of any business combination. According to a 2019 study by Deloitte, business executives increasingly cite successful post-merger integration “as the single most important factor that leads to a successful transaction (23 percent this year, up from 21 percent last year).”[3] Despite that acknowledged need to focus early on firm integration, many recent studies suggest the failure rate of mergers and acquisitions lies somewhere between 70 percent and 90 percent.[4]  Now, new challenges threaten effective cultural due diligence in the wake of the Covid-19 pandemic, and the hurdles in assessing whether business combinations might prove successful have become increasingly difficult to surmount. In a new paper, we discuss these challenges and how companies can address them.

Perhaps the most challenging and important component of successful post-merger integration involves ensuring the cultures of the combined companies fit.[5] Yet the Covid-19 pandemic has made assessing cultural compatibility substantially more difficult.[6]  Most if not all, cultural due diligence will be conducted virtually or remotely. As a result, acquisition teams will experience difficulty in understanding the inner-workings of an organization without the typical person-to-person interactions, without walking the floors, and without the ability to read a “vibe” from the hallways. This lack of cultural data, especially the “gut feel” data, could hinder effective deal valuation and structuring.[7] And more profoundly, many cultural and compatibility risks may be hidden or festering (e.g., temporary and/or reoccurring layoffs, remote working arrangements, health-related absences).

Cultural Due Diligence Strategies in the Pandemic

In addressing this pandemic “new normal,” acquisition teams should consider embracing advanced technologies and new forensic strategies to identify potential risks. By applying somewhat unconventional tools, such as internal and external cultural surveys; virtual dialogue sessions among managers, employees, and important corporate stakeholders;  and predictive analytics to identify new avenues for cultural cohesion, integration teams can gain a much more robust understanding of cultural risks and potential rewards that could materially affect deal price, the structure of a transaction, and the likelihood of long-term post-merger success. [8]

Utilize Artificial Intelligence

Even before Covid-19, new technologies, such as artificial intelligence (“AI”), were rapidly changing M&A due diligence.[9]  The pandemic “new normal” necessitates prioritizing this innovation to unlock post-crisis growth by expanding AI to enable remote cultural due diligence data capture and analysis.[10] Both those conducting the cultural due diligence and negotiation phases can gain insight into what cultural incompatibility risks the deal will likely encounter by collecting data that transaction teams have been historically unable to collect, clean, and analyze.[11] AI tools can also assist in compiling more granular cultural data that would traditionally take untold hours for acquisition teams to formulate manually. With the use of AI tools, more channels for data mining become available for cross reference and validation.

Conduct Surveys to Evaluate Cultural Risks

Informal and formal surveys may help to substantiate or evaluate cultural risks presented by the pandemic.[12] Remotely hosting interviews and focus groups may be an acquisition team’s only choice in getting a sense of the attitudes, cultural preferences, and decision-making styles within an organization. Informal interviews and focus groups can provide acquirers the opportunity to identify important similarities and differences that affect post-merger compatibility.[13] Those informal interviews or internal climate surveys can be carried out virtually by top executives, the target company’s deal team, mid-management, or key employees.[14] Informal climate surveys provide an incredibly useful tool to ferret out potential legal, regulatory, employee, or integration issues.[15]

Embrace Cultural Definition Opportunities

Acquisition teams should turn culture issues that can be mitigated and managed into an advantage. —Cultural rifts can be recast as opportunities to reshape corporate identity and to address potential integration pitfalls.[16] Using the newly available cultural data, teams should also formulate business strategies and messages that mitigate cultural roadblocks and lead to acceptance of the change.[17] The strategies and messages should prioritize the vision of an evolving organization that addresses the pandemic, as well as market challenges or opportunities faced by both organizations. Furthermore, the unification of the combined company’s goals and objectives in addressing the special challenges presented by the Covid-19 pandemic might be useful in overcoming any employee or stakeholder resistance to the deal.[18]

While culture due diligence will be conducted in new and creative ways, harnessing emerging AI due diligence technology and considering unconventional ways of collecting data can help to complete an internal and outside-in culture-compatibility assessment.  These assessments will enable better price and deal structure and better prepare the organization for successful post-merger integration.

Implications

Attending to the new normal in M&A regarding cultural due diligence and integration planning will likely have a number of important implications.  First, the cost of conducting an acquisition will most certainly be affected.  Second, deal structures will likely change given the increased uncertainty associated with Covid-hampered due diligence.  Market experts suggest there will be changes in “material adverse effect” provisions, increased information demands, greater specificity in Covid related representations and warranties, and post-closing price adjustments, among others.[19] Third, flexibility and an appreciation for uncertainty will need to occupy more prominent roles in any integration plan.

In many respects, the path of the pandemic has already sufficiently established that we simply “don’t know what we don’t know.” That persistent uncertainty counsels adopting a flexible approach to integration that attempts to gain comfort in advance with uncertainty itself.[20]

The lesson is not that M&A strategies should forgo new ways of fact finding and simply rely on sophisticated deal structures to recoup anticipated deal value when integration efforts falter.  Instead, the implication for cultural due diligence in the wake of Covid is that the very notion of what constitutes corporate culture may be fundamentally changed.  Attending to that evolution and how firm culture gets embraced or rejected represents an essential focus of proper acquisition planning.

Conclusion

The advent of the Covid-19 pandemic has created substantial hurdles for negotiating, pricing, and effecting successful M&A transactions.  Although acquisition activity has certainly declined in the pandemic’s wake, an increased reliance on new and emerging strategies for conducting effective cultural due diligence could help M&A rebound.  Those new strategies might affect the cost of conducting M&A transactions, the deal structures employed, and the need to embrace uncertainty in planning for successful integration of firm cultures.  In the end, although the pandemic should not prevent effective cultural due diligence in M&A, the pandemic might change the very notion of what corporate culture entails.

ENDNOTES

[1] See Kostantino Makrygiannis, Conditions ripe for already resilient M&A activity to accelerate in 2021 and Beyond, EY (13 Dec 2020), https://www.ey.com/en_gl/news/2020/12/conditions-ripe-for-already-resilient-m-and-a-activity-to-accelerate-in-2021-and-beyond.

[2] See Richard D. Harroch et al., The Impact of the Coronavirus Crisis on Mergers and Acquisitions, Forbes (Apr. 17, 2020), https://www.forbes.com/sites/allbusiness/2020/04/17/impact-of-coronavirus-crisis-on-mergers-and-acquisitions/#78a7f0a3200a.

[3] Russell Thomson et al., The State of the Deal: M&A Trends 2019, Deloitte (2018), https://www2.deloitte.com/content/dam/Deloitte/us/Documents/mergers-acqisitions/us-mergers-acquisitions-trends-2019-report.pdf.

[4] Clayton M. Christensen et al., The Big Idea: The New M&A Playbook, Harv. Bus. Rev. (Mar. 2011), https://hbr.org/2011/03/the-big-idea-the-new-ma-playbook.

[5] See May Hu & Pei Ni Huynh, How Do Cross-Border Mergers and Acquisitions Affect Firms’ Management & Stakeholders?, 20 Corp. Fin. Rev. 21, 23 (2015); Oliver Engert et al., Assessing Cultural Compatibility: A McKinsey Perspective on Getting Practical about culture in M&A, McKinsey & Co. (June 2010), https://www.mckinsey.com/~/media/McKinsey/Business%20Functions/Organization/Our%20Insights/Merger%20Manager%20Compendium/A%20McKinsey%20perspective%20on%20getting%20practical%20about%20culture%20in%20M%20and%20A.ashx; Michele Gelfand et al., One Reason Mergers Fail: The Two Cultures Aren’t Compatible, Harv. Bus. Rev. (Oct. 2, 2018), https://hbr.org/2018/10/one-reason-mergers-fail-the-two-cultures-arent-compatible.

[6] See Michael Thompson & Alexandra Melia, Cross-Border M&A Challenges During COVID-19: An Overview For Buyers and Sellers, Steptoe (June 1, 2020), https://www.steptoe.com/en/news-publications/cross-border-manda-challenges-during-covid-19-an-overview-for-buyers-and-sellers.html.

[7] See People Risks in M&A Transactions, Mercer, https://www.mercer.com/our-thinking/people-risk.html (reporting that the highest people risks includes failure to consider culture fit).

[8] See Martin Hirt et al., Bubbles Pop, Downturns Stop,  McKinsey Q. (May 21, 2019), https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/bubbles-pop-downturns-stop (discussing resilience and impact to organizational change).

[9] See Michael R. Siebecker, Making Corporations More Humane Through Artificial Intelligence, 45 J. Corp. Law 101–13 (2019).

[10] Jordan Bar Am et al., Innovation in a crisis: Why it is more critical than ever, McKinsey & Co. (June 17, 2020), https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/innovation-in-a-crisis-why-it-is-more-critical-than-ever.

[11] See Using Advanced Analytics to acquire and retain the best talent during M&A, McKinsey & Co., https://www.mckinsey.com/business-functions/organization/our-insights/the-organization-blog/using-advanced-analytics-to-acquire-and-retain-the-best-talent-during-m-and-a.

[12] See Tiffany Yates et al., M&A: Assessment Key To Avoiding a Culture Clash, GrantThornton (Oct. 29, 2018), https://www.grantthornton.com/library/articles/advisory/2018/M-and-A-assessment-key-avoiding-culture-clash.aspx.

[13] See Nuno Fernandes, The Value Killers: How Mergers and Acquisitions Cost Companies Billions–And How to Prevent It, 41–45 (Palgrave Macmillam) (2019).

[14] See David Harding & Ted Rouse, Human Due Diligence, Harv. Bus. Rev. (April 2007).

[15] See Id. at 128.

[16] See Engert et al., supra note 6.

[17] See Elizabeth Long Lingo & Kathleen L. McGinn, A New Prescription for Power, Harv. Bus. Rev., July–Aug. 2020, https://hbr.org/2020/07/a-new-prescription-for-power (discussing generally the ability of leaders to enable change management).

[18] See Jeremy Hof & John Luce, Culture Shock: Anticipate the Risks When Companies Merge, KPMG (2019), https://advisory.kpmg.us/articles/2019/anticipate-risks-when-non-tech-tech-companies-merge.html (discussing overcoming a culture gaffe by focusing on winning together).

[19] See Harroch et al., supra note 2.

[20] See Mark Herndon & John Bender, What M&A Looks Like During the Pandemic, Harv. Bus. Rev. 3–5 (June 10, 2020).

This post comes to us from Michael R. Siebecker, Maxine Kurtz Faculty Research Scholar and professor of law at the University of Denver’s Sturm College of Law, and Iris Lozano, a third-year student at the University of Denver’s Sturm College of Law. It is based on their recent article, “Cultural Due Diligence and M&A in the Wake of a Pandemic” available here.

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