Performing Cultural Due Diligence to Better Understand the Target Company

0:00Emerson, Block, Cardinal Health, Broadcom, Toast, Energizer, Jam, Treehouse Food, Coram, name. There's too many to list. What do the best corporate development teams in the world have in common? They use Dealroom. Add a crappy data room and Excel trackers. In 2021, Emerson did an$11 billion acquisition on Dealroom. Then this year, a$14 billion platform divestiture to Blackstone. Even with every big bank name involved in the deal, they all had to use Dealroom. Learn why the best in M &A combine diligence and integration into one workflow so they can get both diligence and integration done faster.

0:47To execute M &A like the best, you have to know how to use Dealroom. See for yourself at dealroom.net. Again, that's dealroom.net. Let's get to the interview.

1:01I'm Kisan Patel, and you're listening to M &A Science. where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies, and what actually happened during M &A deals.

1:25Hello M &A scientists, welcome to the M &A Science Podcast, where we learn from the best in M &A to uncover proven techniques for enterprise value creation. If you're interested in learning more about the products and services we developed to support world-class M &A teams or want to get involved with a community of forward-thinking M &A practitioners, visit mascience.com. That's where you can subscribe to our newsletter, join a roundtable and network with some peers, find a ton of free content. Again, that's mascience.com. I'm your host, Kisan Patel, CEO and founder of M &A Science. Joining me today is Ken Bond, Head of Corporate Development at Cetera Financial Group.

2:08Cetera is a leading U.S. investment advisor network with over 12 ,000 producing financial advisors and 800 financial institutions with over$475 billion of assets under administration. Today, we're going to talk about how to perform cultural diligence to better understand the target company. Ken, how are you doing today? I'm well, thanks. Good to see you, Pisa. I'm excited about this topic. I know some people listening might be rolling their eyes like, he's not talking about culture again. But people have got such conflicting views on it. You get some of the old school corp def folks who are like, ah, culture, we're going to create a new culture.

2:46Who cares? And then you hear about all the issues that bubble up once an LOI signed. But then what do you do? Do you push a deal through the finish line? And then it gets really tough. And then other people are like, that's HR's job. So this is always a fun topic to talk about because the more we talk about, the more I realize how important it actually is for each deal you work on. Can we kick things off with a little bit about your background? Absolutely. I look after corporate development for Cetera Financial Group. As you mentioned, Cetera is a leading U.S. investment advisory network. We've got 1 ,000 advisors and half a trillion dollars on the platform.

3:17So we're number two or number three in the industry, depending on how you manage it. I've been professional my entire life with a very odd background. My background's in physics, drove submarines for the Navy and nuclear engineering for a little bit. And then I came out and did consulting with McKinsey before I got into corporate development. So I came at it from the strategy side as opposed to the investment banking side, which is, I think, an anomaly. I think that helped me build some good processes and practices when setting up high-volume M &A shops. Ran corporate development for Aon for roughly 13 years and got about 250 deals done, a little over$3 billion of deal value.

3:54value and then joined Cetera three years ago and spent another$3 billion in only three years and already had about 25 deals done. So I've been pretty active and really enjoy it. I'm what you would clearly label a deal junkie. I love doing transactions. Got an operating experience, tons of M &A experience, and then driving a nuclear sub. That's pretty interesting. That could be a whole podcast of its own. I don't know how you do that. I could imagine being underwater for any period longer than I need to. How my nuclear experience changed, impacted my corporate development profession. Actually, there's a direct correlation, believe it or not.

4:30I'm sure around discipline and just... Discipline of a value process. The value process. The Navy encourages you not to wing it when starting up or shutting down a nuclear reactor. And the same thing should be true with processes for acquiring and selling firms within an organization. process is the muscle that organizations use to learn. And you need good process in order to retain those learnings. Otherwise, they just reside within individuals. And when the individuals leave, those learnings leave as well. Well, that's really well with M &A. Disclaimer out there, Zetara is a Dealroom customer.

4:59Those of you probably know, I'm pretty involved with it as a founder CEO of that business. But that's it. That's not what this podcast is about. We're going to talk about cultural diligence. So first things first, who's in charge of cultural diligence? Just like everybody else, the CorpDev team is responsible for executing diligence or ensuring that diligence is done on the target company. Individual functional owners or leaders of those diligence efforts are responsible for their unique areas. I would argue that yes, HR is a big portion of evaluating culture and they should own an understanding of what the cultural diligence yields.

5:34I would put on the HR professional. So you do put on the HR professional, but it sounds like there's some supporting that HR professional? Oh, absolutely. Your diligence plan has to assess that. Let's talk about why this is important first, and then we can talk about how we assess it, and then we can talk about how we mitigate the findings out of our assessment. So there's three different phases here. So why is it important? One of the presidents that I used to work for, probably one of the most influential leaders I've ever worked for, for that matter, when it came to M &A, certainly held the position and said on stage, culture eats strategy for breakfast, meaning if you've got a bad cultural fit, it's not going to overcome a good strategy.

6:11I would modify that slightly to say that culture is certainly an important consideration that has to drive your integration plan. I wouldn't necessarily walk from every deal that's got a bad cultural fit, but you most certainly want to adapt your integration plan to accommodate for the findings of your cultural diligence. So that's why you want to do it. When you start looking at your diligence plans, you do a great deal of cultural diligence already. The problem most folks run into is they don't really aggregate the findings from a cultural perspective to bring that diligence lens to bear. Let me give you some examples.

6:48We review the employee handbook, employee policies and procedures. You're doing a number of one-on-one interviews with functional leaders. Maybe it's the IT, maybe it's HR, finance. Each of those leaders is probably getting interviewed during your diligence effort to understand aspects of their systems, aspects of their policies or procedures, or whatever it might be. It's more likely than not you're going to have one-on-one interviews with them. And in that process, you will be able to assess how they make decisions, how they delegate, how they engage with other functional leaders, and how they view their collective team and whether that's a healthy team or not.

7:26The employee handbag is also going to give you some good insights there, as well as policies and procedures for everything from time off to diversity inclusion, all the different policies and procedures that they roll into the firm, of which you will certainly evaluate. What's missing is bringing together all of those findings from a lens of culture. Ask the question, what insight have we gained from the diligence we've done about the culture of the prospective firm? That makes sense? So that's where you get an understanding of how they work when you mention how they delegate decisions, the leadership approach in the organization.

8:03Should we start from the beginning of where do you actually start cultural diligence? It actually starts with making sure that your diligence plan ensures that the data or the findings that will come out of your diligence effort are evaluated from a perspective culture. Meaning, Kizan, you probably already have, if you look at your diligence plans that you've got and had many discussions about how to conduct diligence at a functional level. If cultural diligence is done right, I would argue you don't really need to modify those plans dramatically. What you need to do is to pull together the findings that come out of those functional diligence efforts and evaluate the findings from the perspective of what insight into culture did we gain from the materials and interviews that were conducted during our effort?

8:52You can then form a view around, okay, what are the key attributes of culture, decision-making, and community that they have? The other important component, of course, is the acquiring entity also needs a similar level of an evaluation. For global organizations, each of the countries is almost always has its own little microcosm of culture. It's not common across a global organization or even the individual sites. Your California office may look very different than your Kansas City office or your Florida office. So if the Kansas City office is doing the acquisition, make sure you understand the culture that they're walking into.

9:30Target and acquirer both get evaluated. And then you can understand, you at least have an understanding of where the friction might be as you begin to integrate the two organizations together. So this isn't so much about having a whole work stream of doing cultural diligence. It's baked into your current approach of doing diligence. It's more about extracting that information and looking into those findings that are specific to culture. And then you also had a good point. Know thyself, what your organization's culture is. Absolutely. And all this stuff ultimately lends to planning the integration.

10:05What are those things you really need to think about? Exactly. In rare instances, you may blow up the deal and just say, listen, this is a bridge too far. It's going to be oil and water. It's simply not going to work. We'll either lose the people or the clients or both. And ultimately, this is likely to be a disaster. Rarely has that ever happened. But in a couple of instances... What does that look like? Like, I'm gay, because you're right. It rarely happens. But I'm just curious. Personal experience is all I can give you. What I have seen is from smaller transactions, owner-operator, where the owner is going to become a W-2 employee of the acquiring entity and is critical to maintaining client relationships post-close or customer relationships post-close.

10:47And they are larger than life figures. They are very proud of the businesses they've built and they may not play in the sandbox well with others. It might rise to such a level that you just simply don't think that they're going to be manageable or that they are going to look after the best interests of the combined entity. And fundamentally, if you don't ultimately trust them as you continue to do cultural diligence and you find out that they're, you believe fundamentally they're untrustworthy individuals, then that's a good reason to back out of the deal. Senior people and their role as a company.

11:20For sure. More likely than not, the issue is they're very centralized. They don't really push decision-making down like we do. As we integrate their functional teams into our functional teams, they are not going to have as strong a direction for how their work should be done that they're used to having. and they'll be asked to operate on a significantly more autonomous basis and that's simply not going to work well for them. So we need to be thoughtful about how we bring the two teams together so that we can overcome that. Sales teams may go about prosecuting opportunities in a very different way.

11:56So I'm not talking just about business processes, differences in business processes, but how their culture of collaboration or how they engage the rest of the organization in constructive and hopefully in a very constructive way. If it's very antagonistic between functional areas, just as a general finding, then that alone will tell you you've got a little bit of work to do. You might want to spend a little more time getting to know you before you bring them in, not necessarily walking away from them, but certainly the findings around cultural diligence should influence the speed and depth at which you choose to integrate the businesses.

12:32What you do find is that whether you choose to integrate within one month, three months, six months, when the reductions happen that inevitably come with those types of integrations, those one-time costs don't sink a transaction. And if they could sink a transaction, you need to rethink your pricing. That deal might be a little too rich. They shouldn't. One-time costs like that generally shouldn't. It's run rate synergies that you ultimately really need to get in order to make a transaction work. If you're levering, then lenders are going to give you 12, 18, 24 months in some cases. It really depends on what the market looks like when you go to get the lending.

13:12On whether when you can achieve those synergies. So you've got time. It's better to be thoughtful about the timing of when those savings are realized and to give yourself the greatest chance of success. All we're saying here is that the more armed you are in setting up that integration plan, The more data you have, Ultra being a key component of a key data point that has to be folded into the architecture of that integration plan, that's going to give you a better chance of a successful outcome. You just compact a lot there. Okay, let me step back a minute. The real deal breaker stuff doesn't happen very often.

13:48Usually it's like a real, basically CEO or somebody really key that's not going to be a fit. That's going to deter getting the value out of the deal. That's good you clarified that. I was imagining walking in the office, everybody had like face tattoos. And I was like, oh, I don't think this is going to work out. But I've never had that happen. I'm not saying that. That's a different bias thing I got to go see a therapist about. Anyways, then from there you went into, okay, so there's still a lot of things you want to acknowledge because ultimately this goes to how you're going to plan integration.

14:17You mentioned the speed and depth of integration and it's going against the timeline of capturing synergies. That's where I wanted to dive a little bit deeper because it's almost like a little matrix here because I want to get a sense of those factors of cultural differences that you acknowledge. And then, hey, we have a lot of commonalities. And do you look at that and say, this is how it's going to shape the integration plan versus what are those differences? Is it they have top-down management? We're very bottoms up. Maybe we got to look at this a little different. Maybe we do have those teams operate more independently and focus more on the backend integration.

14:50Is there like a playbook or just pattern you've seen Playbook, yes, absolutely. I think each organization builds their own playbooks based upon past precedent and how they're organized and how they best ingest organizations that they acquire. I guess what I'm saying is that those playbooks are never rigid. They always have to adapt to the circumstances of each transaction. I'm not saying anything you probably don't know on that. They're really more like guidelines. They're starting spots. You start with the playbook, but then you have to adapt the playbook to the peculiarities of a transaction.

15:23And one of the peculiarities of the transaction is the culture of the business, which is how do they make decisions and how do they manage their people? How do they push risk? What's their willingness to take risks and how do they reward or punish mistakes? And that has to influence how you go about bringing those teams together, whether you allow them to continue to operate autonomously and side by side as like their own little cell within a functional area. So you want to keep the core team together, but it'll now be managed the acquiring company's department head. Or do you intermix the teams such that they're indistinguishable post flows from who was acquired and who was acquired?

16:05There's different ways that could play out. And there's no reason not to be thoughtful so that you can get the best possible outcome. Every company's culture is unique. But can you profile them when going through this exercise? I think you can. There are certain attributes you care about. And you lay those out upfront in your diligence kickoff. This is one of the work streams that you're going to highlight, just like everybody else. And the person in charge of HR generally also says, listen, we're also going to be evaluating culture. Just to be clear, I'm looking for the following items. I'm going to come back to each of you after you do your one-on-one interviews.

16:37I'm going to spend 10, 15 minutes with you on an interview to debrief on what you found when you were engaging with the sell side. From that, I will then aggregate findings across all of the different interviews and our own diligence materials, such as policies, procedures, handbooks, etc. And I'll form a view around what they look like. I will share that at the final due diligence readout so that people who are also building the integration plan are aware of what they're walking into. So they've got, especially the leaders, because the leader of the integration, that business executive will certainly care a great deal about whether there's likely to be friction or not.

17:15Can we talk more about the how? Sure. One, I'm curious, I always find the first early interactions like really fun when you're talking executive to executive. Are there things there in those really early conversations that you may want to ask to start getting a sense of culture? You're always getting it. Whether you realize it or not, it's playing a role in your bid strategy, in your engagement strategy, and how you are positioning the combination of the firms. If they care a great deal about autonomy, you're going to try to feed that. You're trying to find a solution that allows them to get what they need out of the transaction.

17:51But at the same time, you're starting to evaluate whether it's a healthy organization or not. Here's the point that's probably most relevant. in a process where you are very limited in your engagement with the management team and it's very controlled. A bank controlled process we're talking about, right? You get a four-hour management meeting, you get some very scripted meetings that are supervised by either ParentCo or the banker. A couple hours, 30-minute meetings with functional leaders. Add that up, you probably get another four or five hours max with the sell-side management team. You don't have a lot of time there to come to an understanding of what their culture actually is.

18:29It could be all theater. You're very likely getting the best of who they are. And we've all seen that. Once you get into diligence, inevitably, it's like you're two weeks away from signing the transaction and you realize that, oh, the CEO actually hates the head of HR and the IT guy can't be in the same room as the CEO. Jeez, that's not helpful. It impacts your retention plan as well. So there are personalities there that you need to make sure you understand and your ability to evaluate culture is more constrained in that environment. If you, however, are doing a bilateral where you either have prior history or you've got an elongated kind of engagement with the seller, then it's a heck of a lot easier to form a real view around what the culture of the business is, which is another reason why bilaterals are so much better than auction processes and generally yield to significantly better outcomes because you just get a better feel for who the actual people are and a more true assessment of their culture.

19:27Really good point. Can you define bilateral? Just feel like it's a kind of an ambiguous word. Two people, two parties. You and me are going exclusively through a conversation. There's nobody else involved, not running an auction process. So you aren't engaging with five people, just you and me trying to see if there's a deal to be done. Cool. Otherwise we can call it a proprietary deal. Yeah, it applies. Bilateral is good. I like it. So I want to clarify the banker situation because you're right. Bilateral, you have a relationship, maybe you're already partners. I'm the CEO for years. You got a good sense of the culture.

19:58You visit their office. Those are a big help. Let's say that banking situation. One of the key things that you mentioned was understanding how the organization delegates and make decisions. What do you do to do that? Do you just ask them directly? Or is there certain things you may try to conclude to that? You're going to find that out either at the management presentation when you start talking through kind of different functions. Fundamentally, you've got to understand what do you call service and ops and what do we call service and ops and who does call center, what do we call center professionals?

20:27Everybody got a different lingo and you need to go through the process of lining all of that up. For nothing else, you need that to understand, make sure you're doing apples to apples comparisons, either on gearing ratios or work structures when you're looking at mashing things together. And in that process, you're also going to talk about, well, who's got control and how do decisions, particular decisions get made. You could talk about large capital expenditures, large IT programs, or how individual hire-fire decisions get done and what does a budget mean. And there's lots of different nuggets that will come out of a free-flowing conversation during that four-hour management meeting that just need to be captured from that perspective.

21:05Alternatively, you're also going to be having conversations with the CIO so that you can better understand the architecture of the business. In some instances, a discovery session where you've got a broad range of stuff that you want to get a feel for. A free-flowing discovery session is the most efficient way to muddle your way through the diligence process. In that, you will almost always be asking some specific questions about who makes that decision? How do you manage? How many people do you manage? And what are their roles and responsibilities? How engaged are you in this architecture decision?

21:38How engaged are you in these particular programs or are they delegated to X, Y, or Z? So you'll get a feel for that during those engagements. So you're going to get a way better read of the culture through those conversations as opposed to just sending a checklist for diligence? No. Yeah. You can't send a checklist, right? What you just described, it's like you can't really... I mean, you can tell if someone's lying, basically, just the way they were supposed to. Again, everybody's super busy on due diligence efforts. The last thing you want to do is add a new work stream for somebody to go do.

22:12It's much better if you can leverage the existing materials that are going to come out that you require anyway, and just analyze the data from a different perspective. So I'd argue cultural diligence is a bit like that. You're already gathering that information. We're just simply using that data and that information for a different purpose. Makes a lot of sense. You mentioned, too, the key things are getting the handbook and HR policies. Are there things that you just really look for right away when you get those assets? We've seen train wrecks in policies and procedures. Don't get me wrong. There's lots of things you're looking for.

22:46Compliance with local labor law is somewhat critical. But understanding how centralized control there is and how levels of gifts that they're allowed to receive from vendors to what they can do for office entertainment to office parties and celebrations even. There's lots of different little tidbits that you can pull out there to say, this is an attribute of their culture that's very different than ours. And just be aware. Gives you the groundwork for when you do have those in-person conversations of what are the areas to look into. Yeah. For example, they have free snacks and coffee in their offices and we don't have any of that.

23:23Okay, great. Be aware. That's an attribute that they find valuable and it's been that way for a while. And when you bring the two teams together, it's going to come up. Interesting. What's like the weirdest thing you've seen in a policy like that? I haven't even gotten any great horror stories other than the transactions that we walked from because the cultural fit was just too bad or probably we should have walked from. We certainly highlighted a couple of deals that the cultural fit was obviously so bad that we didn't recommend proceeding forward and that ultimately you don't have to be a genius to see what's going to happen after close.