Merger boom triggers rush to investigate likely partners

Lawyers and investment bankers aren’t the only professionals benefiting from the surge in merger and acquisition activity.

Before investing millions of dollars in an acquisition, buyers naturally seek legal and financial advice. But they also want to find out as much as they can about their potential partner. Does its accounting accurately portray the health of the business? What kind of reputation does its management have? What is its corporate culture?

Companies targeted by hostile would-be acquirors have the same questions. Part of their strategy for thwarting a hostile bid can be uncovering information they can use against the unwanted suitor.

To answer these and other questions, buyers and sellers turn to people such as Mark Bremer, president of Stax. The global strategy consulting firm’s services include providing due diligence for companies involved in mergers and acquisitions.

“It’s been a very busy time for our practice in this area,” said Mr. Bremer, who works in the Chicago office of the global firm.

Private equity firms hire Stax to analyze the growth prospects of prospective targets. Other firms investigate the credentials of management and the board; analyze the prospective target’s accounting practices; or assess legal, environmental, cyber and other risks.

“We’re trying to help clients understand who these people are that they’re doing business with,” said Peter Turecek, a senior managing director for Kroll, a global firm that also helps companies investigate fraud and data breaches and provides other services.

Firms in the due diligence business rely in large part on publicly available documents: U.S. Securities and Exchange Commission filings; real estate records; corporate registration papers; civil, criminal and bankruptcy court records; and news stories. They also will look at what actions regulatory agencies have taken against a prospective partner and confirm the academic and professional credentials of the company’s management.

“What it all boils down to is the type of work any investigative reporter would do,” said former investigative reporter Paul Quinlan of Quinlan Partners.

His Charleston, S.C., firm relies on former investigative reporters to perform due diligence for clients across the U.S. Mr. Quinlan said a single piece of information from public records may not provide much insight, but putting all of those pieces together can produce a surprisingly detailed picture of a prospective business partner — or reveal troubling discrepancies.

However, data found in public records does not tell the whole story. To obtain more qualitative information, Quinlan Partners and other firms conduct interviews with former executives and other industry sources who can round out the portrait of a prospective partner.

“There’s a lot of important information that’s not contained in public records that people can tell you,” Mr. Quinlan said.

Mr. Turecek, who works in Kroll’s New York office, referred to interviewing competitors and others in the industry as “reputational sourcing.”

“That can be very critical for understanding whether the melding of cultures [after a merger] is going to work,” he said.

In the case of a hostile takeover, Mr. Turecek said the targeted firm often asks its due diligence provider for a broader, more detailed investigation of the unwanted suitor.

“In that kind of situation, you’re plumbing every depth you can find,” he said.

Mr. Bremer said that in addition to analyzing existing research on the size of the market and how fast it is expected to grow, Stax will interview industry sources to get their opinions. Once a private equity client acquires a company, Stax will help the portfolio company achieve its potential, he said.

“More than ever, investors want to understand the growth prospects of what they’re buying,” Mr. Bremer said. “Our work is an input to their broader due diligence.”

Mr. Turecek said some clients find out the hard way that limiting their investigation can cause problems. He compared due diligence to the process of screening job applicants rather than conducting a thorough background investigation.

“In this business, you get what you pay for,” he cautioned.

“If you try to go cheap, you may end up with a false sense [of security] with the answers you get.”