Tips for better use of Due Diligence

by | Jun 12, 2011 | Business Intelligence, Due Diligence, Investigation & Background | 0 comments

Home | Tips for better use of Due Diligence

It is all too common to hear about the business that went broke or lost millions following a decision to enter in an investment, joint venture or merger with another company that turned terribly sour. All that glitters is not gold. The usual reaction is to query how on earth such bad mistakes were made and why the warning signs and red flags went unheeded. “Didn’t these people know how to do Due Diligence?” is the common refrain.

That’s a valid comment — proper Due Diligence can certainly prevent such business fatalities. But that’s not where Due Diligence starts and stops. Whatever the type of the business relationship; whether it is with a local family company or a multinational group, you are electing to engage in a multi-year relationship with a business, organisational culture and people you barely know.

As the business progresses and the business cycle moves, relations will be strained due to many factors including; difficult clients, dropping revenue, slim profit margins or loss of key agents. How will this affect the relationship and what will it need from your side to keep things on an even keel?  What procedures and agreements can be implemented to resolve issues before they become points of conflict?

The employment of proper Due Diligence can address these issues in a systematic and methodical way prior to them occurring. Due Diligence in business should not be the preserve of upscale law firms or PE [Private Equity] firms; any business or corporation seeking to undertake a major business or financial transaction should employ some measure of Due Diligence.

Due Diligence means different things to different people. For accountants it usually relates to the P&L, asset register and balance sheet whilst a lawyer will be looking more at the IP, contract agreements and related clauses.

However, commercial Due Diligence seeks to identify any red flags or issues with the business in areas including:

  • Backgrounds of key personnel
  • Product or service – state of the current market
  • Key customers – what are the long term relationships, chance of deserting the firm
  • Litigation – have they been party to or subject of civil litigation
  • Intellectual Property – what do they possess, is it owned or licensed, registered, integral to their business
  • Suppliers – what are the relationships, are the suppliers being paid on time or any possible disputes
  • Government involvement – need for permits or licences, how may this affect business
  • Competitors – who are they, are they related, what threats do they pose
  • Agreements – what other parties hold a stake in the business [unions, NGOs etc]

As Due Diligence becomes better known among business people and executive teams, issues arise as to how it should be applied, what phase of the relationship and under what circumstances. Proponents of Due Diligence often come upon objections or queries.

We have summarised some of these objections below with corresponding rebuttals:

Issue 1
Only investor firms conduct Due Diligence such as banks, lenders and Private Equity firms.

Answer 1
Though investor firms have been the leading users of Due Diligence [often simply as a legal requirement written into the deal], Due Diligence should not be limited to these users solely. Any business or organisation seeking to enter an agreement which involves a risk or threat to the business should undertake some form of Due Diligence to identify and potential risks and seek to address and mitigate them. Why not do as the experts do?

Issue 2
Some people or businesses take offense when told that there will be a Due Diligence profile undertaken.

Answer 2
These are far fewer in number than you’d think. Anyone willing to benefit from an investment, contract or Joint Venture should expect to have some form of background check done on them and their business – they’ve filled in a credit card application before with no tears.

The nature and focus of Due Diligence will be adjusted to suit each particular transaction. Most participants will be impressed that you have your act together and are taking the relationship seriously and want it to be successful, where’s the harm in that?

Issue 3
We did a media search and it showed that the business was once mentioned in a Supreme Court case – that makes them unsuitable.

Answer 3
This piece of information has to be viewed in context. Was the business a defendant or litigant or possibly an uninterested party? When did this happen and what were the findings of the court? Or was the matter discontinued and may be considered frivolous? Is the same management in place or have there been material changes?

A proper Due Diligence exercise will seek to lay out the details of any court case and what implications this had on the business or the main parties. Jumping to conclusions based on one incident is impractical and doesn’t grant the exercise the patience that it deserves.

Issue 4
Due Diligence is all about looking for problems such as a lawsuit by a former employee or action by a government department

Answer 4
Though these can be important facts uncovered during Due Diligence, they should be properly reported in context and due weight given to the issue. [If the issue was toxic leaks from the plant poisoning local drinking water, that would merit serious attention. If it was a minor fine for an unregistered vehicle then that would be relegated down the list of importance and reporting].

As mentioned above, Due Diligence is usually engaged to identify threats or issues not disclosed in the normal business relationship exchange. These points may include criminal record checks, civil litigation checks in state or federal courts, product history, key markets, Intellectual Property and a review of each office or location. The onus is on the profiler to meticulously search and review databases, compile the results and conduct discreet interviews with human sources whilst knowing from experience what to look for and the significance of the results.

Issue 5
Due Diligence is too focused on talking to people who’ve dealt or worked with the subject company.

Answer 5
Human intelligence can be invaluable in providing timely and intricate information regarding a company or its senior personnel. However, caution has to be taken upon relying too heavily on their disclosures with cross referencing; is the source aggrieved or enamoured with the company to such an extent so that his information is polarised?

It takes an experienced investigator and profiler to obtain useful information in an unbiased manner and then seek to weigh up that information against what else is known or reports from other individuals. This takes time but does produce a well rounded and complete picture of the company at the time.

Issue 6
Due Diligence can make some people feel uncomfortable

Answer 6
Again, this is because they are unfamiliar with the Due Diligence process. We are all affected by Due Diligence processes in our working lives from applying for a bank loan [confirming our identity, ability to repay the loan etc] to obtaining a passport [divulging personal information to the government].

As long as the Due Diligence process is explained thoroughly along with the benefits and positives from seeking to get to know the other party better before becoming involved in a long term relationship there are few dissenters from our experience.
Do you need to know more about our services and how Regents can assist you with Due Diligence? Simply go to our Business Intelligence page for our phone numbers or else send an email to contactus@regentsriskadvisory.com with your contact details and we will respond at once.

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