Due Diligence Failures
The most dramatic example of a failure to date has been the BNP Paribas debacle. The due diligence was good but management overloads what they were told.
So how does due diligence work in practice?
Firstly, failing to perform due diligence is in many cases not as bad as poor due diligence. At least with failing to do any comprehensive research we tend to take more time judging the parties with which we are going to do business. We know there is a gap between information known and information desired and we guard ourselves accordingly.
Cheap due diligence, or due diligence done for the sake of a box checking event is the most dangerous and fails at every level. It gives one a sense of false confidence that all is well and that, yes indeed I have done my due diligence.
The best example I have is that of National or world wide background checks done for a paltry sum, from $120 domestic to $750 international. All these do are search databases about the nation or the world. Even much of the United States is not computerized or not accessible without visiting the courts and paying a fee. There are horrendous over sells of a product and a service that lead to heartache and worse.
Insufficient resource is another recipe for failure. Insufficient time, small budgets, and lack of subject matter expertise are hobbles for the due diligence professional. Even the finest aeronautical engineers around the world cannot build an aircraft without proper access to time, talent and treasury. Why do you think a due diligence professional should be any different?
The choice has been made and you are there to verify the choice that has been made. That means that if the information in the due diligence report is anything but vanilla or laudatory, you risk the power struggle of your coming up against a senior executive that has already made a choice. In short, you are making them wrong. Mind you, this is their set up and it is set up to blow up in their face, but you will be in the room when “the pin is pulled” on the report grenade.
Too much time and money is also a problem. Due diligence is time sensitive and resource constrained by definition. Not all questions can be asked and answered in a timely fashion and if the questions were asked and answered some months ago – the follow up question is whether the answers have gone stale? All research must be focused, timely and driven to ask and answer questions in such a fashion as to give management the necessary information upon which to make a choice.
Inappropriate people are selected to drive the due diligence process such as lawyers and accountants. It is crucial to understand that in most cases their presence is required, but they should not be the driver’s of the research. As the old expression goes, to a plumber, all problems revolve around pipes and all problems for an electrician deal with wiring. All due diligence does not revolve around accounting or laws, though they are part of the information that is to be sought. The due diligence team should be run by a due diligence professional that understands – audits are not due diligence, and lawyers do not run business – but managers with good information – from all subject matter experts can make well informed choices.
The “All Hands” meeting is not where the due diligence is presented. The “All Hands” meeting is the final meeting to ensure that all issues have been dealt with and that there is no unasked or unanswered questions left, allowing the underwriting to proceed. Long before the “All Hands” meeting there would have been several smaller shorter meetings discussing with directors the findings of the due diligence team. These finding will impact on everything from price paid, form of capital, staffing questions, all which down the line that need to be made upon well informed due diligence long before the “All Hands” meeting. It is the ongoing due diligence process that leads up to even being able to have an “All Hands” meeting – by the time of the “All Hands” meeting all due diligence will have been completed, digested and its impact will have significant impacts on how any transactions were crafted. By this time the due diligence professionals have completed their tasks and all of their presentations. The “All Hands” meeting should never be the theatre of “Oh boy, look what I found!”
Due diligence failure stems from not understanding that due diligence is a process not a thing, a verb or a noun. Failure stems from trying to make the process into something that it is not – it is not a panacea, a magic elixir, or a guarantee. Due diligence is the authentic ongoing process of understanding what is behind the curtain thus gaining an understanding of both the risk and opportunities that are around you.