I talked about Due Diligence in a previous article, and gave you 13 ways to spot lies and deception.  Here’s an additional list that’s specific to Information Technology, although you can probably see parallels in other types of due diligence:

12 More Ways to Spot IT Lies and Omissions

1. The current solution doesn’t scale up
   Maybe there’s a small-scale version of a certain capability working, but it’s not ready for the large-scale production you’re going to need.  For example, a certain process is done by hand, and isn’t yet ready for mass production.
2. The current solution doesn’t scale down
   This is less common, but still a concern.  Sometimes a system only works for large volumes, and isn’t cost-effective when scaled down to lower volumes.  That can be a concern in a fluctuating economy.
3. The seller is evasive on version numbers and specific types of hardware and software
   This is often a tip-off that the seller is using outdated equipment or unsupported software versions.  It can also mean that the seller is using unlicensed software.
4. The number of people in an area doesn’t make sense
   You’re given an organization chart that shows a certain number of people in an organization, but you know from personal experience that this number is too high or too low for the work that needs to be done.
5. Omitted business functions
   Think about the processes and business functions that need to be performed in a company like this.  Have you gotten a description of the people and systems for every one of them?  If not, then how are they done?  Are they outsourced?  Has certain information been held back?
6. Customer list doesn’t match revenue
   Either the seller is claiming more revenue than can be accounted for, or the revenue seems low given the number of customers the seller is claiming.  Either way, further investigation is needed.
7. Lack of clarity around ownership of rights
   For any proprietary software or hardware that is being used by the seller, it’s important to get a legal document from the seller stating that they have complete intellectual property rights for that software or hardware.  If any part of the development of that software or hardware was outsourced or subcontracted, then the seller should be able to produce legal documents that show that the outside resource holds no rights.
8. Informal subcontractors
   If the seller uses an informal arrangement with subcontractors where they may legally own rights to some of their work, then you may be in trouble on the purchase.  You may have to get signed documents from every current and previous subcontractor assigning the rights to the seller.
9. Person who did the work is no longer with the company
   This introduces two issues: (a) intellectual property rights, and (b) the possibility that no one currently with the company knows enough about the previous work done to maintain it or enhance it.
10. There is no (or not enough) budget for maintenance and replacement of equipment
    In some cases the seller will strip “unnecessary” items like maintenance and equipment replacement out of the budget so that the P&L (profit and loss statement) will look better.
11. No contingency or disaster plans
    Like #10, in many cases the seller will try to operate without any contingency or disaster plans in an effort to minimize cost.  This obviously introduces a high degree of risk for the business.
12. Lost in technology translation
    This is like #13 from the first list but it refers to the situation where a business claim is made by the seller that can’t be supported by the technology the seller is using.  For example, the seller claims 24×7 system availability, but only has one server with no fault tolerance.

Related posts:

1. 13 Ways to Spot Lies and Omissions in Due Diligence We all do due diligence.  Some of us do it in mergers and acquisitions (M&A).  Some of us do it when we’re getting ready to make a major purchase like a house or a car,...
2. Acquisitions 101: Why Companies Acquire Other Companies If you haven’t been involved in an acquisition, then wait a few months; it eventually happens to all of us. In preparation for that event, it’s useful to get an understanding of why companies do...
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We all do due diligence.  Some of us do it in mergers and acquisitions (M&A).  Some of us do it when we’re getting ready to make a major purchase like a house or a car, or when we’re getting ready to sign a contract for major home repair.  Due diligence is the research you do to make sure that what you buy is what you think you’re buying.  It’s verifying that the “facts” are correct as represented by the seller.

When witnesses are sworn in before their testimony in a court of law, they swear to tell “the truth, the whole truth and nothing but the truth.”  It’s the “whole truth” part that’s usually the problem.  The whole truth means that they have revealed all aspects of the truth — they haven’t just answered a question in a truthful but deceitful way.  This is also the primary area of concern in due diligence: someone may answer a question truthfully, yet they’ve held back the information that you really need to hear.  President Bill Clinton’s famous statement, “I did not have sex with that woman,” is an example of the truth but not the whole truth.  He interpreted the words the way he wanted to, and told the truth as he wanted you to see it.  And in due diligence that’s exactly the same thing that sellers are likely to do.

From my own experience in M&A due diligence for over twenty acquisitions, here is my list of ways to spot lies and omissions:

13 Ways to Spot Lies and Omissions

1. Less detail in one area
   When information is provided to you, there’s a consistent amount of detail provided in most areas, but less detail is provided in a few areas.  There’s usually a reason they don’t want to go into detail in those few areas, and it’s in your best interest to find out why.
2. Too much detail in one area
   This is the opposite of #1, but the intent is the same.  When you’re getting too much information about one area, you tend to pay less attention to the areas where the real concern is.  They may be using a red herring approach — distracting you from the real problem areas.  Or they may be concealing the problem area by overwhelming you with other information in the same area so that finding the truth will be like looking for a needle in a haystack (worse, actually, since you don’t know that it’s a needle you’re looking for).
3. They keep changing the subject
   Whenever the discussion gets around to a certain area, somehow the subject gets changed and the area never gets covered.
4. People in one area don’t ever seem to be available
   Isn’t it interesting that the experts you really need in an area never seem to be available?  There’s probably a reason.
5. Discussion on one area keeps getting pushed to the end of the agenda
   When the seller knows you have a time constraint (like a scheduled flight), they keep pushing the problem area to the end of the agenda, hoping that you won’t take the time to do a thorough job.
6. Accomplishments and plans blur together
   This is particularly common when you’re discussing the capabilities of a system or process.  The seller talks about planned capabilities as if they’re available today.  This overstates the capabilities and gives you the impression that you’re getting more than you really are.
7. The verb tense keeps changing
   This is usually a tipoff that the seller is doing #6.  Sometimes the seller says “the system will do something” and sometimes the seller says “the system does do something.”  Or perhaps different people talk about the same capability: some using current or past tense, and some using future tense.  Make sure you know exactly what capabilities exist today.
8. Conflicting answers from different people
   If different people give different answers to the same question, then the answers are suspect.  Some sellers avoid this problem by making sure that all of your contacts stay in the room for all of the questions.  That’s why it’s better to break up your due diligence into smaller groups for some of the detailed questioning.
9. Physical cues: speech, tone, body language
   Listen to the seller’s answers, but also notice how the seller is answering.  In particular, look for differences in physical cues when certain subjects are being discussed.  Sellers often exhibit stress when they’re talking about a subject where they know there are some concerns.  The stress is visible when they act differently during discussions on those subjects.
10. Web site and advertising don’t match what they’re telling you
    If the seller is telling customers one thing and potential acquirers something else, then there’s probably a problem.
11. Denial without explanation
    The seller denies certain things, but makes no attempt to explain, probably because there isn’t a good explanation.  Don’t take “no” at face value — ask why, and ask for examples to clarify the issue.
12. Everything is perfect
    I don’t mean to be cynical here, but the reality is that all acquisitions and purchases involve trade-offs.  If your due diligence shows that everything is exactly as you would like it to be, then look closer, because something is wrong.  I’ve never been involved in due diligence where everything was perfect; in all cases we had to decide whether the weaknesses we saw were outweighed by the strengths.
13. Lost in translation
    When doing due diligence in a non-English-speaking country, the discussions usually have to be done through a translator.  It’s best (although more expensive) to use your own translator in addition to the one provided by the seller.  If your translator is part of the due diligence team and committed to your success, then your translator should be able to listen for differences between what the seller says and what their translator tells you.  Your translator should also be able to pick up on foreign-language discussion among the selling team participants.  Often this discussion can reveal seller weaknesses or issues that the seller is hiding.

Next week: 12 More Ways to Spot IT Lies and Omissions in Due Diligence

1. The seller wants to meet offsite, away from the office
   This is normal.  They probably don’t want employees to know, and they don’t want to start rumors.  This is particularly true for M&A of public companies, where insider trading rules are extremely strict.
2. Seller wants a confidentiality agreement signed before any discussion
   This makes sense, and it goes both ways.  If the deal falls through, then neither the seller nor the buyer want a lot of press, and they don’t want their secrets used against them.
3. Seller wants you to destroy your notes if the deal falls through
   This is reasonable, especially if the buyer and seller are competitors, since trade secrets may be revealed.  It’s extremely important if the buyer or the seller is a public company.
4. The seller hesitates in including certain people in the discussion
   Most sellers want to keep the possible M&A deal on a need-to-know basis.  The more people they include, the more likely it is that news of the deal will leak out.  Note, however, that this conflicts with #4 in the first list.  If you really need to know about a certain area, then you should insist on getting the answers you need.
5. The seller doesn’t want its people to be seen in public with you
   Again, this is to keep the potential deal a secret.
6. Code names for the buyer and seller are used
   This is common.  On the M&A deals I was involved in, we made it a habit to never refer to the seller except by code name — even in private conversations or emails among ourselves.  You never know who might be listening in.  And make sure that the code names can’t be used to figure out the real name of the company (e.g., Redmond for Microsoft).  Pick a name that has nothing to do with the company, their location or the business they’re in.  Hint: Some companies who do a lot of M&A make up a long list of code names in advance, then for each transaction they just use the next code name on the list.
7. If a site visit is needed, then the seller wants to use a cover story
   Again, this is common.  You might be introduced to employees as potential customers doing some background work before making a major purchase.  Technically, you’re lying to the employees, but it’s closer to acting — you’re playing the role of a customer to get the answers you need to be a different sort of customer.

Related posts:

1. 12 More Ways to Spot IT Lies and Omissions in Due Diligence I talked about Due Diligence in a previous article, and gave you 13 ways to spot lies and deception.  Here’s an additional list that’s specific to Information Technology, although you can probably see parallels in...
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I see and hear these words and phrases all the time, but it has gotten to the point where they’ve lost their meaning for me — maybe for you as well. Let’s start with some oldies but goodies then work up to something more current.

Synergy
This used to be the consultant’s ultimate goal. Synergy is a type of magic: it’s creating something from nothing. Or to be more accurate, it’s creating something new out of two old things. Let’s say you have a company and it’s worth $x, and I have a company and it’s worth $y. Using synergy, our two companies together are worth more than $x + $y. That’s the theory anyway.

But wait a minute. Wasn’t there a benefit from two companies working together before the word synergy was invented? What about old phrases like “horizontal integration” and “vertical integration”? Weren’t they about synergy? Sort of. Most people tend to use horizontal and vertical integration as words related to an acquisition — one company actually buys another. What’s different today is that companies are more likely to try to partner with one another without M&A being discussed.

So synergy is like the polite way to do vertical or horizontal integration without all of the nasty complications associated with M&A. It’s like “friends with benefits” instead of marriage.  You can play together without the long-term commitment.

Paradigm Shift
The phrase was first used by Thomas Kuhn in 1962 in his book The Structure of Scientific Revolutions. Kuhn was describing a fundamental change in basic assumptions: something so significant that it created a whole new paradigm. Since then the phrase has grown so common that it has been used in marketing almost any kind of new product.

“Paradigm shift” is now used like any other set of magic words. We wave our magic wand and — presto chango paradigm shift — we see this remarkable result. My rule of thumb: be suspicious of anything using the phrase.  It’s probably a variation on the same old paradigm you’re used to.

Perfect Storm
The phrase came from Sebastian Junger’s 1997 book, The Perfect Storm, and was popularized by the the 2000 movie of the same name. It refers to a combination of weather coincidences which come together (using synergy, I guess) to create a storm of much higher magnitude than is typically seen. It’s like the paradigm shift of storms — everything is on a much higher level: winds, water, waves, general devastation.

I first heard “perfect storm” used in a non-weather context when I attended the Gartner Symposium in 2000. Gartner used it to describe a remarkable confluence of economic and social factors which had created an ideal environment for Information Technology progress, jobs and business influence. Not quite a year later on September 11, 2001, that ideal environment ended.

These days I’ve heard the phrase used to describe the economy. But let’s face it — it only took bad mortgages and widespread sale of mortgage derivatives to trigger our latest economic reversal, and mass panic took care of the rest. Our current economic climate isn’t anywhere near as bad as any perfect storm situation I could envision. So let’s stop exaggerating.

Downsizing
This is a euphemism, pure and simple. We say downsizing when we want to depersonalize the act of firing people. Yes, we may have an economic motivation for takings jobs away from these people, but in a lot of cases the economy is just used as an excuse for getting rid of people we wanted to get rid of anyway.

I understand the need for using euphemisms — I really do. I know that it’s easier to explain things to employees using this word, and this sort of explanation makes it easier for employees to accept their fate. But that doesn’t make it right.

There are worse words. “Rightsizing” is much worse — it implies an ethical basis for firing. I also dislike “force shaping” which seems to compare the whole process to a haircut — “we’ll just take a little off the top.” “Work force reduction” seems like a better phrase — at least it states a fact: the work force is being reduced.

Recession
There are economic definitions of this word (see Wikipedia), but I’m more concerned about the emotional content of the word. While not as bad as the word “depression,” recession is a word that makes people afraid. I’ve said in a previous article that the biggest key to economic recovery is optimism. With an optimistic attitude, people will buy things they need and want, and the economy will flourish. So if you’re using the words recession and depression a lot, please stop. You’re screwing things up for the rest of us. Be optimistic instead, and let’s get the economy back on track.

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2. Are You Wasting Your Resources on “Honey Projects”? When I was a child I learned a funny nonsense rhyme: I eat my peas with honey. I’ve done so all my life. It makes the peas taste funny But it keeps them on the...
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When I was a child I learned a funny nonsense rhyme:

I eat my peas with honey.
I’ve done so all my life.
It makes the peas taste funny
But it keeps them on the knife.

The logic of the rhyme argues that:

1. I eat peas with a knife.
2. But when I try to eat peas with a knife, they fall off.
3. So I should eat the peas with honey so they’ll stick to the knife and not fall off.

I coined the phrase “Honey Project” based on the rhyme; a Honey Project is one that makes a bad solution easier to tolerate. When faced with a Honey Project, you should seriously consider whether the project is worthwhile. After all, wouldn’t it make more sense to replace the bad solution with a better one instead of compounding the problem by dressing up the bad solution?

Here are some examples of Honey Projects:

An Attempted Central Customer Service System
A friend of mine told me about a customer service system that his company tried to put together. They wanted a single system that a customer service rep (CSR) could use to tap into the data of his company’s twenty or thirty different business divisions. The IT people working on the project made the incorrect assumption that a copy of the data had to reside in a central database (eating peas with a knife), so they spent tons of time and money trying to work out the systems and processes required to take daily copies of the data from all over the world. Ultimately the project collapsed due to the number of data translations required, the politics of moving data across multiple IT organizations, and the realization by the users that the data provided in the CSR system wouldn’t be real-time anyway.

In hindsight, the project team should have considered a layered approach, with a single CSR system providing a common interface that goes out to other existing customer service systems under the covers to retrieve data as it is needed. And they should have solved the problem in phases, adding a few business divisions at a time in order to build political support for the central solution. But the project failed because the project team jumped to a bad solution before fully understanding the problem.

Inappropriate Product Acquisitions
I did some work with a corporation that has a history of inappropriate acquisitions. Although it’s a technology corporation, the non-technology-savvy marketing executives have repeatedly discovered small companies with supposedly complementary products (eating peas with a knife). Then the corporation spends big bucks on “integrating” (Honey Projects) the small companies with the corporate products, in most cases spending more than it would have cost to develop an equivalent product internally, and in many cases abandoning the new products after the unsuccessful integration effort.

Doing the right technology due diligence should have prevented some of these small companies from ever being acquired. In this case the corporation asked the right questions during technology due diligence, but the corporate executives didn’t like the answers so they ignored the due diligence results and acquired the companies anyway. Ultimately the due diligence proved correct, and the Honey Projects failed to make up for the shortcomings found in the due diligence. It’s hard to dress up a bad investment.

Microsoft Virus Protection
Microsoft Windows has long been criticized for its susceptibility to computer viruses (eating peas with a knife). Microsoft’s answer to the problem is to introduce its own virus protection product, Microsoft Windows OneCare Live, rather than to fix the vulnerabilities in the Windows product. Thus OneCare Live will become the “honey” that helps to cover up the problem that Microsoft itself created.

Virus vulnerability is a difficult problem for Microsoft to solve. Historically Microsoft has had mediocre initial releases for each of its products, but it has invested large amounts of money on product improvements for later product versions. The computer virus susceptibility in Microsoft Windows dates back to the initial versions of Windows, is embedded deep in the architecture of the product itself, and will require huge amounts of effort to correct. It’s likely that Windows users will live with the Honey Project approach from Microsoft for some time to come, probably until a solid competitor to Windows is available.

Conclusion
The “Peas with Honey” rhyme is about an attempt to salvage a bad decision, and the lesson from the rhyme is to be very careful of your decisions before you start building on them. Too often we make this mistake in IT: we don’t fully understand what’s needed, we put a lot of effort into building an inappropriate or incomplete solution, and then we waste effort on Honey Projects to make the bad solution more palatable.

Take a long hard look at the projects you’ve got going on now. How many of them are Honey Projects? What can be done to solve the real problems and put your resources to better use? How can you change your processes to prevent this kind of problem in the future?

Honey Projects happen to all IT groups, but if you’re going to do a Honey Project, then make sure you’re going into it with your eyes wide open. Try to minimize wasted effort on Honey Projects by taking the time to make the right decisions in the first place. But if that doesn’t work, then try making the right decisions the second time around.

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If you haven’t been involved in an acquisition, then wait a few months; it eventually happens to all of us. In preparation for that event, it’s useful to get an understanding of why companies do acquisitions, so that you can anticipate the effect that an acquisition will have on you. I’ve been lucky enough to represent the acquiring company in more than twenty acquisitions, and so the information in this article is based on real experience. Yet I don’t claim to know all industries or all cultures, and so my understanding is obviously limited to what I’ve observed.

3 Reasons for an Acquisition
In my experience, a company acquires another company for one or more of three reasons:

1. Vertical integration
   To take control of a key supplier, product or service on which the company depends; or to gain the profits that are otherwise going to these suppliers, products or services
2. Horizontal integration
   To fill in “holes” in the product line, to add complementary products, or to add customers in new markets
3. “Synergy”
   That magical situation in which the combined whole is greater than the sum of the two companies separately

Underlying all of these reasons is the assumption that the company wants to grow. The quest for growth is (unfortunately, in my opinion) common to all public companies and most private ones. Investors expect returns from the companies in which they invest, but an increase in stock price only comes from increased revenue per share or, to a lesser extent, increased profitability per share.

Now, looking at the three reasons, we see that the first two types of acquisitions can be done while keeping the two companies at arm’s length—by continuing to run the acquired company as a totally separate business unit. When acquisitions are done that way, the impact on an information technology (IT) organization is pretty much the same as the impact of having to deal with typical partnerships or third-party relationships: mostly interfaces and data feeds.

But I’ve never seen an acquisition where synergy didn’t come up. Attempts to achieve synergy can cause major disruption for IT and almost every other organization in both companies. Since synergy is one of the reasons for almost every acquisition, and because it’s the primary reason in a good number of acquisitions, let’s take a closer look at what synergy is all about. Here are three common synergy scenarios:

Synergy Scenario 1: More revenue, less expense
In this scenario, it is expected that together the two companies will have greater revenues, but that expenses will be lower. Revenues are expected to be higher due to cross-selling between the two customer bases; combining the sales forces; combining marketing and advertising; and due to an enhanced brand. Expenses are expected to be lower due to economies of scale; combining operations; consolidating systems and computers; eliminating duplicate functions and organizations; and in some cases by “centralizing.”

Synergy Scenario 2: Target business is losing money
This is a variation on the first scenario. The “target” company (the one being acquired) has higher expenses than its revenues. But by taking advantage of the techniques listed in scenario 1, the combination of the two companies is expected to be not only profitable, but more profitable than the parent company doing the acquiring.

Synergy Scenario 3: Take the customers
Under this scenario, the parent company doesn’t really want any of the operations of the target company; it just wants their customers. This type of acquisition is common when the parent company is in a business that already provides all of the products or services that the target company’s customers use, and the acquisition is done to add revenue to the parent without going through the cost of acquiring the customers individually.

In a typical acquisition of this type, say in the banking industry, some of the target company’s customers jump ship and refuse to become customers of the parent (the expected percentage of lost customers is factored into the acquisition price). Customer conversion is the key factor here: if customers can be converted to use the parent’s products and services without any disruption or effort on the customer’s part, then most customers will be expected to make the switch.

How does synergy affect IT?
There are a number of questions that an IT organization has to answer in order to deal with an acquisition. First there are the due diligence questions that should be answered before the acquisition takes place. What synergy scenario applies to this acquisition? If it’s scenario 1 or 2, then answer the following questions:

1. Does the target company really have the technology they say they have? Do they own the rights to it (intellectual property rights, current third-party licenses)?
2. Can the combined company benefit from technology economies of scale?  If so, where and how?
3. How easily can data and systems in the two companies be integrated or interfaced to meet company requirements?

If synergy scenario 3 applies (take the customers), then answer these questions:

1. How difficult will it be to replace customer-facing products, systems and services for target customers with the products, systems and services of the parent?
2. What migration path should be used for target company systems and data? How long will the process take (long migrations guarantee more lost customers)?
3. Will the existing parent systems support the increased volume? If not, then what will have to be changed?

Then after the acquisition takes place, there are more questions that have to be answered for all scenarios:

1. How will roles and responsibilities change? You’ll have to get a feel for the new people with whom you’ll deal: what are they like? Can you trust them?
2. What technology economies of scale will you actually implement? What systems will be combined? How will data centers and servers be affected? How can this be done to maximize payback while minimizing disruption to the business?
3. How will data move among the various systems in the two businesses? What integration or interface tools will be used to make the data flow more efficient?

And finally, there’s the question that you ought to be asking yourself whenever you try to take advantage of economies of scale: What’s the likelihood that the acquisition will fail and will have to be spun back off? If we combine systems and organizations, what problems will this create if the business has to be split up again later? Is it worth it?

Conclusion
Acquisitions are a fact of life in business today. Most acquisitions are done in the expectation of some sort of synergy, and the acquisitions that fail usually fail because that synergy wasn’t achieved. With the proper due diligence before an acquisition, you can set more reasonable expectations. And with the proper planning, you can achieve the synergy that your company expects and desires. Acquisitions are like anything else: they’re great if done well and awful if done badly.

[Note: A downloadable PDF version of this post is available.  Click here to get the download.]

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What is this thing called “acquisition due diligence”, and how does due diligence for information technology differ from any other kind of acquisition due diligence? These questions will be answered in this white paper which describes the three IT surprises that you want to avoid.

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