Build your due diligence valuation process around two critical steps (once you have completed and vetted your investment thesis):
- Determine the target’s stand-alone value based on a rigorous understanding of cash flows. Your due diligence process must first establish a baseline—that is, your target’s value under “business as usual” conditions. Key: Most of the price you’re paying should reflect the business as it is, not as it may be after you own it.
- Measure the true value of synergies. 1) Begin by evaluating cost savings, then 2) move out to revenue synergies and account for the probability of success as well as the time required to achieve them, and finally 3) assess negative synergies—such as interruptions to service, lost customers and employee turnover, and subtract these item values from your overall estimate.
Finally, throughout the due diligence process, test what you’re learning against predetermined “walk-away” criteria (i.e., criteria that indicate the acquisition does not make sense…). If any of those tests leads to irreconcilable doubt—walk away from the deal.