Cultural Due Diligence: The Underappreciated Tool To Ensure Post-Merger Integration Success

Navigating the complex human dimensions of mergers and acquisitions was long overlooked. But the concept of cultural due diligence is gaining momentum. This article dives into the fundamental concepts behind cultural due diligence, and how data and software can be used to improve the process.
Cultural Due Diligence: The Underappreciated Tool To Ensure Post-Merger Integration Success

Hugo Joby, Matthieu Quercia

Human Insight in M&A Isn’t New but Is Still on the Road to Maturity

Cultural due diligence is nothing new. As a concept, it started to gain attention in the late ‘80s, primarily driven by a growing number of mergers and acquisitions and a combination of economic, financial, and regulatory factors.

Financial sector deregulations and tax reforms, coupled with increased access to financing and global economic growth, significantly reduced barriers to entry for many actors. Hence this decade set the stage for ongoing waves of M&A activity, and was marked by huge deals in the telecommunications, media and consumer goods industries.

However, it was also replete with high-profile failures, such as the Well’s Fargo/Crocker National Bank merger in 1986, leading to significant public and regulatory scrutiny.

Considering the specter of such economic disasters, companies started to realize that culture played a significant role in the success or failure of these deals. Also, this surge and enthusiasm led to a growing Academic interest. Academia and management literature started delving into the importance of corporate culture and its ties to M&A.

Organizational psychology became a recognized discipline and great papers were published such as the brilliant Making Mergers and Acquisitions work: Strategic and Psychological Preparation published by Mitchell Lee Marks and Philip H. Mirvis.

From a relatively nascent concept in the 1980s to the recognition of its impact on deal success, the concept of cultural due diligence came a long way. It is now a recognized practice for most companies engaged in mergers and acquisitions. However, how do we explain that many M&A endeavors still fail today due to a lack of cultural integration? There is obviously a caveat.

Drawing on age-old wisdom, the practice of human capital assessment in M&A is still on a journey to full bloom.

Cultural Mismatch in M&A: Recipe for Disaster

The Daimler-Benz and Chrysler merger loss of nearly $20 billion (USD), Google’s unfruitful acquisition of Nest for $3.2 billion (USD), the high-priced Sprint and Nextel fusion for $37.8 billion (USD) that led to the emission of a junk bond only three years on, the multi-year rocky acquisition of Whole Foods by Amazon for $13 billion (USD)… the recent corporate history is punctuated by many examples of such financial and reputational disasters: drawing on age-old wisdom, the practice of human capital assessment in M&A is still on a journey to full bloom.

Including culture and human capital considerations as early as possible in the M&A blueprint will plant the seed for early detection of red flags and a smooth action plan by the integration team, which will spring up the so-called synergies and long-term success.

PE Deals Often Skip the People Part in Transactions, and There’s No Blame for That

By PE professionals’ own admission, the human side of the equation is oftentimes neglected when doing a transaction. Of course, they would have talked to the CEO and at best the first layer of the management, but by default or by design, nothing more than that. Assumptions are made about the cultural fit post-merger only based on gut feeling and surface-level techniques, observations mainly.

And they are not at fault.

In many cases, culture does not serve as the determining factor. Its primary purpose often remains to inform integration plans rather than guide negotiations. Given the financial tunnel vision that affects CEOs, board members, bankers, and the broader M&A community, treating culture as a pivotal factor is as likely as a snowball’s chance in hell.

Furthermore, speed is of the essence in M&A scenarios. The longer it takes for the M&A team to align and secure a deal, the more vulnerable they become to market speculation and competitive bidding. Drawn-out negotiations and the inability to promptly secure a mutually agreeable deal can lead to a loss of momentum and, ultimately, the failure of an M&A transaction.

Moreover, the scope of actionable tasks during the due diligence phase is constrained by often-too-short M&A timelines, with deliverables primarily focused on identifying synergies that support value creation. Worse, this trend is set to accelerate, with timeframes shrinking as AI-powered virtual data rooms supercharge the due diligence phase. These tools have become commonplace, enabling more efficient data analysis for deal scaling. From time-consuming tasks like data collection and categorization to screening and filtering, these tools are now widely adopted to streamline data analysis and cut down the duration of due diligence.

M&A confidentiality and cultural assessments are at odds

Furthermore, a culture of confidentiality prevails in M&A matters, and safeguarding the secrecy of the deal is of paramount importance.

Consequently, and during the pre-deal due diligence phases, access to individuals, information, and vital documentation is not straightforward, given the potential involvement of numerous stakeholders and third parties, which heightens the risk of information leakage regarding the takeover.

Asking too many questions might raise concerns and jeopardize the deal’s confidentiality. Additionally, achieving the necessary level of detail in cultural assessments during this stage is arduous, as it necessitates the target organization granting the acquiring company physical access to engage with employees, conduct surveys, or review and analyze organizational documents — a level of access that is rarely granted at this point in the process.

This is why the primary source of cultural information at this stage remains publicly available data, coupled with observation techniques and training designed to provide insights into distinctive factors and behaviors. Typically, short in-person meetings are facilitated by the H.R. department. However, a significant limitation of these workshops is their focus on upper management members and key stakeholders within the target company, leaving managers and their staff as an afterthought, although they play a crucial role in creating value within the target’s assets.

The bottom line of these factors — strict privacy, tight timelines, and cultural assessments primarily based on observation techniques, results in many assumptions being made, leaving the project exposed to potentially disastrous deviations from its initial financial targets.

We need new KPIs to Measure Culture

Shift-left cultural integration brings lots of perks and should start before the ink dries. Despite the challenges, incorporating a cultural assessment early in due diligence offers significant benefits. It enables the inclusion of the right people and key contacts from the start, allowing for a seamless transition post-deal.

Early engagement in this process also helps identify potential issues sooner, enhancing the effectiveness of PMI cultural integration and HR workshops. Strong support from the target company’s sponsor can foster deeper involvement in these activities. Communication about cultural integration is vital and should be treated with the same importance as legal, technical, and financial aspects of a transaction, recognizing that the human element is fundamental to organizational success.

A more comprehensive assessment becomes feasible immediately after the deal’s closure and just before any changes are implemented in the newly formed entity. This phase offers the opportunity to engage both company management and stakeholders while granting access to all the necessary information for conducting a thorough, comprehensible, and actionable evaluation of the cultural compatibility between the two organizations. This approach should no longer only rely on observations but instead incorporate focused, in-depth discussions in a workshop format. The team, no longer under the pressure of tight timelines, is now better positioned to garner support and buy-in for the impending changes.

Culture Clashes impact EBITDA

Strategic integration of human capital post-acquisition is essential to foster value creation.

Post-close operations are frequently undermined by employee attrition. If you’ve faced recurring talent attrition post-close or resistance within the workforce, it may stem from strategic alignment misconceptions, uncertainties regarding job security, or disrupted team dynamics and trust. These scenarios are all too common and have profound repercussions on the bottom line of the investment: knowledge loss, risk to client and stakeholder relations, and opportunity costs, just to name a few.

However, employee turnover is mostly preventable. Start identifying the risks within the target organization human capital by using a data-driven framework to proactively mitigate the human capital risks factors.

Using a Data-Driven Framework Makes It Possible to Measure Cultural Fit Better

Areas of improvement

The importance of meticulously measuring the cultural gap between the acquirer and the target entity cannot be overstated. This step is indeed paramount for developing targeted recommendations and a comprehensive action plan that zeroes in on the primary areas requiring enhancement.

Such criteria need to be selected based on the business vertical, its competitive environment, the prevailing market trends, used distribution strategies, and the overarching strategic direction of the PE firm. Though this methodology is applicable across the spectrum (startups to already established businesses), there is a wide array of factors to evaluate including employee satisfaction, agility, responsiveness to change, the capacity for innovation, and many, many more, which are also not equally weighted.

This is why the data-driven approach needs to be tailored to the environment and iterative, with the assessment serving only as the first step of integration. Such steps can include exploratory conversations, customized questionnaires, and detailed discussions and workshops.

The aim of these efforts is to deliver actionable insights and a robust framework for ongoing monitoring, ensuring that both parties involved in the merger or acquisition feel fully integrated, benefit from clear visibility, and share a deep commitment and sense of ownership over the cultural aspects of the post-merger integration.

Cultural due diligence benefits from data just as much as financial due diligence

Opting for a data-driven strategy enhances the reliability and acceptability of the human capital assessment, setting it apart from mere observational techniques and superficial analysis. This approach gains even more traction in the context of cross-border mergers and acquisitions, where foreign direct investment continues to be a driving force of M&A activity, but not only since disparities can also exist within domestic borders. For example: a New York company adhering to a ‘corporate America’ model vs a startup in Los Angeles.

From knowledge loss, risk to client and stakeholder relations, and opportunity costs. Post-merger integration shouldn’t just address the technical and financial aspects of the merger. Without a proper integration plan, the merging of different systems, policies, and procedures can be chaotic.

Mitigating the risks associated with talent attrition is an opportunity. An opportunity to transform challenges into a competitive advantage, and to protect the value of your investments. Don’t let the complexities of mergers and acquisitions hold you back. Invest in our services today, and make the most of your organization’s human capital.

From knowledge loss and risks to client and stakeholder relations, to opportunity costs, the risks associated with human organizational capital and its proper integration post-closure are multifaceted. These should be addressed to protect the bottom line of the investment. Upscale your acquisition strategy by optimizing human capital. Our approach uses data-driven insights to mitigate cultural risks, leveraging automated data extraction and strategic surveys for comprehensive risk profiling and opportunity mapping. More About Q&J Partners

About the author

Hugo Joby, Matthieu Quercia

Matthieu is an experienced Transformation Strategist, with a specific focus on leveraging data-driven insights to deliver change management strategies that drive transformational success. He engages with top-tier consulting firms and their Private Equity clients in North America and Europe.

Hugo is an experienced Solutions Consultant specializing in IT and tooled transformation, with a strong technical foundation. His extensive involvement with eminent cloud providers like Microsoft Azure and Amazon AWS gave him a rich history in facilitating value creation for merger projects.