This article has been written by Akshata pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.

This article has been edited and published by Shashwat Kaushik.

Introduction

Due diligence is an activity undertaken with a certain standard of care to investigate and evaluate business opportunities by individuals or businesses before entering into a binding agreement. This article aims to understand why cultural due diligence should be considered in mergers and acquisitions. As the world becomes more globalised and interconnected, culture becomes a significant topic to observe and take action on. Cultural due diligence is a factor that helps businesses imply and conduct strategic planning for survival.

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In the complex survival world of business, mergers and acquisitions (M&A) are vital moments in the life of a business establishment. At the same time, financial due diligence acts as a compass for the party, either buyer or seller, with a standard checklist or procedure to understand whether to proceed with the transaction. This activity helps the party understand the transaction from all aspects, such as the set of rights and duties, inherent risk, unavoidable obligation, analyses of financial statements, legal considerations, and other factors. The process helps the party understand what they are acquiring, to whom and how they are selling it.

Even though due diligence is performed, poor execution results in unwelcome events of financial liabilities and burdens on the parties to the transaction; M&A shows a promising prospective between the two companies. However, culture is often a crucial element that is overlooked or ignored.

Thus, the concept of “culture due diligence (CDD)” steps in and simply means a step towards a deeper understanding of the human side of any transaction offered for M&A.

What is culture due diligence

In simple words, CCD means analysing the cultural compatibility between the acquirer and target companies. It will consider the parameters of intangible elements such as leadership style, communication pattern, employee retention rate, employee attitude, etc.  It makes one go beyond the financial number and aspects to make the acquirer aware of the changes if the deals take place, such as a change in resistance to change, loss of key talent, discomfort as a level of employment may overlap based on merits, etc. Financial metrics will confirm the ongoing concerns of the company, but CCD assessment will give a state of affairs if successful post-merger challenges are identified and if any cultural differences are identified.

Across various organisations in the home country or target company, some similarities exist. However, each unit has unique and specific values, beliefs, and common grounds regarding how they work and function, as well as their benefits and weaknesses.

Four types of culture

Charles Handy, a management consultant and professor at the London Business School, developed the Four Types of Culture and published them in his 1978 book “Gods of Management.”

In his theory, each culture has four aspects, as follows:

Power culture- It is often identified in a place of business with one boss, such as a family-owned business, which could be listed or private. The listed company will have family members in positions such as chief executive officer or chairman.

Role culture is often identified in government agencies due to its significant hierarchical level. The work is based on a specific person’s role as stability, efficiency, and predictability are more relied on than the person.

Task culture is often identified in industries due to the required problem-solving skills. The work is based on the person’s ability to get the desired results and the number of problems solved or handled.

Person culture- It is often identified in partnerships or small consulting firms as individuals at the centre of tasks. The work is given to individuals according to their ambitions.

Edgar Henry Schein was a business theorist and psychologist who was a professor at the MIT Sloan School of Management. He was a foundational researcher in the discipline of behaviour.

Schein’s model of organisational culture consists of three layers

  1. Artefacts and behaviours- The first layer is the most tangible element to be viewed, such as the dress code, the layout of the office, or how people behave.
  2. Espoused values- The second layer is how the organisation keeps its strategic, objective beliefs or norms. For instance, an emphasis on lower cost or value added to the service provided.
  3. Basic underlying assumptions- The last layer indicates certain assumptions taken for granted. It could be said that ‘paradigm,’ which means a set of fundamental beliefs held in common, such as the promotion of employees, is based on individual, not team, success.

Hofstede’s cultural dimensions theory was created in 1980 by Dutch management researcher Geert Hofstede, who conducted an extensive survey during the 1960s and 1970s, investigating variations in values within different sectors of IBM, a global computer manufacturing company.

Hofstede identified six categories that define culture:

  • Power distance index- It means that if a place accepts a high power distance index, it has a culture that accepts inequality and power differences and promotes brides, which could be the opposite if it agrees with a low power distance index. This index impacts the employees’ workout efficiency as well as their power to get work done.
  • Collectivism vs. individualism.- It clearly states that there is a place where an individual is accepted for personal development and a collective place where the goal is more excellent and loyalty matters.
  • Uncertainty avoidance index- This index indicates the tolerance level to react and responses to uncertainty avoidance for a better understanding of how one will respond in a lacking structure or vigorous system.
  • Femininity vs. masculinity- It helps to understand whether the company is gender-neutral or biassed. Masculine cultures include competitiveness and assertiveness; feminine cultures emphasise relationships and consensus.
  • Short-term vs. long-term orientation- It explains how the organisation operates with its objectives, its results and achievement timeline, and its pursuit of employees.
  • Restraint vs. indulgence- It explains how the organisation will react and respond to the rules and regulations implementation and monitoring.

Thus, the above few theories explain and assess how cultural due diligence could be conducted and the parameters required to understand and imply it.

Importance of cultural due diligence

Employee morale and productivity

A cultural fit provides a balanced work environment, motivating and boosting employee morale and productivity. Cultural differences can lead to confusion, malpractice, frustration, and lower employee productivity.

Talent retention

If any organisation has cultural differences, that could result in the departure of talented personnel, especially if employees feel insecure due to the new organisational culture. Retaining top performers is essential for business continuity and the benefits of the merger or acquisition. The ultimate gain or benefit of the merger or acquisition depends on the performance of the top employees. In today’s time, the average employee’s stay in any organisation is between two and five years. Thus, it is important to retain top-performing employees.

Customer experience

With globalisation, the company will have customers from all geographical demographies, where cultural differences change customer interactions for the service or product consumed, along with the impact on its quality and customer satisfaction. An organisation with good cultural understanding and consistency will result in a satisfied customer experience, enhancing its brand reputation and loyalty. It is also worth understanding the view of a peer group or customer-interest group towards a product or their willingness to respect and be relevant in a specific segment.

Integration success: Cultural integration is a vital part of the pre-merger to determine M&A success. Companies with suitable cultural differences are more likely to benefit from factors such as cost savings, databases, the economics of scale, lower dependence on a single vendor, and market share, resulting in increased post-merger integration. 

Critical components of cultural due diligence

Top-level management style

CCD depends on the approach of the strategic level management, be it the CEO, COO, etc., and other board members’ styles of leadership and management. The style of flow states the nature of the freedom given to the staff of any organisation to share and understand their way to achieve the goal. If CCD is well-defined, it will result in better ground for the company post-M&A.

Employee communication flow

If the company has a culture that allows the employees to communicate and present their thoughts and ideas over any project or assessment, this could help to get a clear picture of how to maximise output with limited resources available.

Workplace diversity

If the company has certain conditions that could make any person embrace the rules that help to maintain respect, dignity, and a common attitude to complete work and restrict toxic behaviour or unethical practices that are harmful to society.

Organisational structure

The organisational structure or hierarchies indicate the decision-making channel; if the workplace has a cultural line in authority and independence, it provides smoother processes. The same will not be the culture in a family-owned business or small-scale firm, which will change if M&A happens with a larger organisation.

Case studies for the effect of CCD on M&A

The merger of Chrysler and Daimler happened in 1998 and its breakup occurred in 2007 One of the main reasons was the conflict in company culture, as per Harvard Business Review. It becomes the basis for a case study to understand why cultural due diligence is of utmost importance for the success and long success of two companies that combine to become one.

Microsoft acquired LinkedIn for $26.2 million, making it one of the biggest tech acquisitions ever. It shows that cultural similarity helped LinkedIn’s revenue increase by 21%.

Framework for conducting a cultural due diligence process

Preparation:

  • Define the scope and objectives: Clearly outline the specific areas of cultural due diligence to be addressed, such as values, norms, communication styles, decision-making processes, and leadership styles.
  • Assemble the team: Put together a cross-functional team with diverse backgrounds, perspectives, and cultural expertise relevant to the target company or region.

Data collection:

  • Desk research: Gather publicly available information, such as annual reports, press releases, employee reviews, and news articles, to gain an initial understanding of the target company’s culture.
  • Interviews: Conduct in-depth interviews with current and former employees, executives, and other stakeholders to gather firsthand insights into the company’s culture.
  • Surveys: Distribute anonymous surveys to employees to collect quantitative data on cultural aspects such as job satisfaction, work-life balance, and perceptions of management.
  • Observation: Spend time observing the target company’s workplace environment, interactions, and events to gain a firsthand feel for the culture.

Analysis:

  • Cultural mapping: Create a cultural map that visually represents the target company’s cultural dimensions, such as power distance, individualism-collectivism, uncertainty avoidance, and masculinity-femininity.
  • Cultural gaps: Identify any potential cultural gaps or misalignments between the target company and the acquiring organisation.

Integration planning:

  • Cultural integration strategy: Develop a cultural integration strategy that outlines how to address identified cultural gaps and leverage cultural strengths in the post-acquisition integration process.
  • Communication plan: Create a communication plan to effectively communicate the cultural integration strategy to employees of both organisations.
  • Training and development: Design training programmes to help employees understand and adapt to the merged culture.

Implementation and monitoring:

  • Implementation: Execute the cultural integration strategy through various initiatives, such as cross-cultural team building, mentoring programmes, and cultural exchange events.
  • Monitoring and evaluation: Continuously monitor the progress of cultural integration and make necessary adjustments based on feedback and outcomes.

Reporting and documentation:

  • Reporting: Regularly report on the cultural integration process to senior management and stakeholders, highlighting successes, challenges, and lessons learned.
  • Documentation: Maintain comprehensive documentation of the cultural due diligence process, including research findings, analysis, and integration plans.

Conclusion

Cultural competence is important in M&A negotiations, affecting organisational performance and merger success. Implementing effective integration strategies through an active exploration of cultural alignment reduces risks, maximises communication, and adds value for stakeholders. The inclusion of appropriate cultural diligence means a commitment to creating a cohesive organisational culture, which sets the stage for long-term success in a rapidly evolving business environment.

References

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