Risky business
Investors instinctively understand the importance of making legal and financial mergers and acquisitions. However, things tend to get off the rails when it comes to conducting due diligence. Most investors simply don’t understand the role of operations due diligence, and the result is that most M&A failures can be traced back to ineffective operations evaluation. Legal and financial due diligence is done to determine the legal and financial status of a business at a particular time, usually the day a deal is closed. Operations due diligence, on the other hand, determines the company’s ability to maintain its operations over time. Question: Are there potential operational risks that could cause future business failure? Investors rely on their attorneys and public accountants to carry out their legal and financial due diligence, but they often attempt to conduct due diligence themselves rather than involve someone with experience in risk assessment. Worse yet, they perform a partial risk assessment by looking at management, sales, or strategy, etc. but it does not evaluate the entire company.
The recent bankruptcy of the solar company Solyndra has now become the model for unsustainable business. Without delving into the politics of bankruptcy or all the possible reasons for bankruptcy, it is fair to say that investors in Solyndra, including the US government, did not effectively assess operational risks that could affect the ability to Solyndra to maintain its operations. .
The following are just two examples of the operational risks that Solyndra faced. First; Former employees have publicly stated that they were throwing away as much as $ 100,000 worth of faulty solar cells every day. If this is true, the operations due diligence should have identified the high cost of quality as a potential risk to the sustainability of the business. Identifying that risk would have allowed investors to insist that a mitigation plan be put in place to reduce or avoid these costs. Second; As part of her marketing plan, Solyndra was looking for a proprietary product design. As the price per watt of standard solar panels began to fall, particularly those made by its Chinese competition, Solyndra was unable to make corresponding reductions in the price per watt of its proprietary products that would allow them to remain competitive. The inability of Solyndra products to compete has been attributed to the commodification of standard panels and unfair competitive practices by the Chinese. However, the reasons for bankruptcy are not important to this discussion. Effective operational due diligence would have identified operational risks and their potential impact on business sustainability.
We can assume that Solyndra’s investors had a sufficient number of lawyers and accountants. However, neither quality risk nor competitive risk in these examples would have been apparent in legal or financial due diligence and effective operations due diligence was never performed.
Unfortunately, just as many investors misunderstand the role of due diligence in operations, many companies still do not understand the importance of implementing a formal risk management program and are reluctant to provide the funds for risk management activities. Solyndra should have identified its own operational risks and developed mitigation plans to avoid them. Companies that manage their risk improve their sustainability. If it is important for investors to conduct a risk assessment as part of their due diligence, isn’t it also important for a company to conduct proactive risk assessments on an ongoing basis?
With the release of ISO 31000: 2009 (Risk management principles and implementation guidelines), some companies are beginning to implement risk management programs in earnest. Unfortunately, even in these businesses, risk managers often have trouble justifying funds to support their activities because senior executives have trouble justifying the cost of the program because it is difficult to measure the benefits of better sustainability.
An effective risk assessment, whether performed by an investor during the M&A process or as a proactive self-assessment of a business, should assess risk across all business operations. It is not enough to say that we look at the management team or the sales department, etc.