Investing in Innovation

Established businesses facing growth limitations within their traditional markets are increasingly looking to acquire smaller, disruptive market players to pursue further growth. These start-ups typically offer innovative higher-technology solutions or leverage online platforms to circumvent traditional and asset-heavy routes to market, which presents a unique set of uncertainties compared to acquiring established companies. In particular, their short track records, entrepreneur-led structures, and limited experience with multinational-level corporate governance calls for a different approach to due diligence.

The value of gathering market intelligence (Integrity Due Diligence, or IDD) is well understood in terms of assessing potential involvement in bribery and corruption or other illegal activities, in particular in higher risk jurisdictions. However, IDD can also play a valuable role in helping an investor understand the culture, operations, and potential governance risks of disruptive start-ups. This information not only supports due diligence efforts but also informs negotiation and integration strategies.

While Integrity Due Diligence can be conducted through public records, engaging human sources within the relevant sector and jurisdiction offers richer insights into the target company. Such intelligence gathering can be tailored to various needs, and the following examples highlight risks we have identified in the past:

• Retention of Key Personnel: intelligence revealed that a highly innovative technology company relied heavily on the expertise of a very small group of technical staff. Industry sources indicated that these key individuals were planning to leave post-acquisition, and this knowledge allowed our client to restructure the deal to incentivise their retention.
• Poor Governance Standards: a rapidly expanding disruptive tech company had robust customer data protection policies on paper. However, intelligence from former employees revealed these policies were not implemented in reality and developers routinely accessed, analysed, and utilised personal customer data, posing a significant regulatory risk to any acquirer.
• Misrepresentation of Operations: our client was informed that a target’s regional team functioned as a think tank, spearheading innovation. However, intelligence from industry insiders revealed this team was more of a repository for problematic senior employees, whom the founder felt too loyal to dismiss outright, and who had minimal impact on actual operations.
• Unique Workplace Culture: a fast-growing start-up possessed a very unique workplace culture stemming from its eccentric founder, which might pose significant integration challenges with a conventional corporate setting. However, industry sources indicated that while the founder had been instrumental in assembling a strong team at the company, he was no longer essential to operations. This allowed the client to refine their acquisition strategy, in light of talent retention and integration plans.

Gathering intelligence is a relatively low-cost exercise which can help companies to identify – and also remediate – issues which might prove expensive to resolve further down the line. These risks might include reputational damage, business failure, and regulatory fines or litigation. IDD can be conducted at any stage of the transaction process, but adds greater value to the M&A process if it is done sooner rather than later.

For more information, please contact Jorge Rivera (jorrivera@deloitte.co.uk) or Rick Dickerson (rdickerson@deloitte.co.uk) in Deloitte LLP’s Corporate Intelligence Services team.