Entering Business Combinations: Strategic Partnerships, Mergers or Joint Ventures - Part 2

In Part 1 of the series on business combinations - mergers, strategic partnerships or joint ventures - we highlighted the 4 factors to consider before entering a term sheet or deep due diligence of a business combination:

1. Alignment of Character/Business Philosophy
2. Human Capital and Physical Assets
3. Market/Product/Reputation
4. Financial Health. 

Some transactions propel companies ahead while other similar transactions cripple them – they stagnate, leadership becomes unclear and both parties start reviewing the exit provisions of the transaction documents.  After watching deals succeed and fail over the years, I began to ask myself, what are the common threads?  Becoming comfortable with the 4 factors above will make it more likely that you move into successfully negotiating a term sheet and then entering due diligence.  

This blog will discuss factor 2 - Human Capital and Physical Assets and lay out some basic questions to consider.  No business will succeed without capable people and quality equipment.

Human Capital

People build business, so it's important to figure out the quality and capabilities and any baggage that the people of your target or potential partner have on their team.  Here are some introductory questions to ask:

1. How does ownership treat senior management?
2. How does senior management treat their team?
3. How does ownership and management interact with their team on tours?  Is there a high level of respect among the team?
4. Does the organizational chart make sense or does it indicate that the organization has been built around some historical dysfunction?
5. Are there a base number of qualified people in each functional area of the business?
6. How is employee retention?  Are people incentivized to help the company succeed?

Physical Assets

1. Are the target's physical assets capable of manufacturing the components of the product you want to create?  The equipment needs to be able to physically do what it is you want it to do; if not, you need to make sure that there is sufficient outsourcing in place to fill the gaps.
2. Does the target have capacity for expansion?  Is there substantial room for capacity expansion through additional shifts in manufacturing?
3. Does the target have capable design and manufacturing engineering?  How is the leader of engineering?
4. Is the target able to produce new products or services timely and of high quality? Does the target have a strategy for improving products or services?
5. How does the target do in capturing intellectual property in the form of trade secrets, trademarks, patents and other know-how?   
6. How is the quality of the target's products and services? 

Brainstorm other questions, meet with the leaders in a relaxed environment and weave these questions into the conversation.  You are more likely to get more open feedback when people are relaxed.  Then spend some time writing out the answers you heard – where do you see alignment and where are the gaps?  Dig into those areas.  What do you need to verify?  What makes you excited?  What gives you heart burn?  As outside general counsel to growing companies, we sit in on and participate in these discussions frequently.  We are close enough to your business to know your business but far enough away to bring perspective to the conversation.  If you are considering a business combination transaction such as a merger, joint venture or strategic partnership and need counsel, please contact us.