Due Diligence: The Basics You Need To Know

Due diligence, sometimes it isn't so clear as to what it is, other times clients just don't know in how many circumstances it really can be used. We will demystify due diligence and help you understand some basics about how to use it.

Brass Tacks

In it's simplest form due diligence is an investigation into a company or person before a significant transaction takes place; the sale of a company or the hiring of key personnel C level executives, etc.

Due diligence, generally speaking, is not a covert investigation. Contrary it is a very overt, careful and necessary function during the consideration — most often — of a merger or acquisition and all parties are aware that certain, if not all, aspects of the company, board members or business deal are subject to a thorough review, audit and investigation.

Due diligence helps decision makers make more informed conclusive determinations as to whether the transaction is sound in all aspects.

Key Areas of Due Diligence Include...

Since there is an inherent risk in assimilating, merging or starting any business transaction, especially in the case of M&A, all aspects of a target company are investigated as to the solvency of its assets; including customer retention, staffing and production, to name a few.

The importance of looking at the key areas of a particular target company cannot be understated.

Imagine company A was looking to acquire company B. All looked well, financially, production, R&D, managerially, etc. However, customers of company B were not contacted, and if they had been company A would have known that a takeover by company A would result in the loss of 23% of B's client base. The reason is irrelevant, but if a carefully constructed due diligence investigation does not look at the details, the devil may be hiding in those details and devalue an investment.

Knowing negative issues with any company up for M&A is not necessarily a bad thing. There may be opportunities, but bargaining and leverage may be needed thus improving the value of the proposition.

Some key areas investigated during due diligence may be:

  • Production

  • Human Resources

  • Customer Relations

  • Research and Development

  • Compatibility

  • Financial

  • Management

  • Information Systems

  • Legal

  • Regulatory

Is Due Diligence Only For The Big Boys?

No. Due diligence is scalable for all business deals and management appointments and cost is relative to the context needed in order to make an informed decision.

Take for example: Becky's Bagels. Becky is investing $35,000 of her own money and another $15,000 from family along with $50,000 secured with collateral from a lending institution.

Becky is following here dream to open a bagel shop using only organic products with gluten free gourmet options.

However, before Becky opened shop with 3 employees, plus herself and $40,000 in equipment and supplies and a 5 year commercial lease valued at $116,0000; she didn't truly count the cost. She didn't perform her due diligence.

If due diligence had been part of her startup, she would have learned about a serious flaw in her 5 year plan. The neighborhood she opened business in was in store for some major changes. Some of the artsy buildings on the same block were, that housed an artist community, was going to be demolished to make room for a new state-of-the-art animal county shelter. The plan was in planning for 3 years and was breaking ground the summer after she had only had her shop opened for 5 months!

The impact was tremendous. Local artists, weekend shows and out of town guests would no longer be visiting that part of town. The animal shelter wasn't a very promising flow of customers either. Becky's relatively small, but hopeful investment was quickly lost.

This is just a small example of what can be overlooked if a competent due diligence consultation isn't considered. The cost that was proposed to this client for her due diligence consultation and investigation: $3,500 — sadly that was too much money for her "budget". (some facts changed to respect privacy)

What About Due Diligence Pre-Hire?

When hiring key personnel such as executives, partners or other upper management, due diligence is part of the process. More than a background check, pre-hire due diligence understands that hiring an executive is similar to acquiring any other asset and you need to make informed decision before you make a $3,000 investigation a $300,000 problem.

Let's say that the executive you are considering for a C level position has a first year salary of $300,000 or suppose the salary is less, but onboarding this executive, moving costs, supplies, training, marketing costs, fees paid to agencies, etc amount to $300k.

As part of our investigation we found a civil lawsuit where this executive was sued for sexual harassment. In addition we found inconsistencies with his actual education verses his claimed education and his real tenure at a corporation -- he was president of!

Yes, the $3,000 due diligence investigation is real and, in fact, this person was hired for a C level position before we were retained, however, he was dismissed within a couple of months of being hired. The total cost of onboarding this executive was:

—$22,000 relocation costs

—$11,000 rental allocation

—$3,2000 in marketing materials

—$44,000 in salary and benefits

If we were engaged before the candidate was selected total cost $3,000 (our due diligence fees).

The Point of It All

Due diligence is an audit and investigation process that is conducted overtly prior to making a decision on in important executive hire or before a start-up merger or acquisition. It looks at many points of the business to ensure the solvency is what is represented at the outset.

Due diligence investigations are completely bespoke and this customization allows for scalable solutions that meet both budgetary and practical needs.

Should you like to engage our professional due diligence investigations, please contact us.

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