Why we shouldn't shun due diligence
30 November 2022Brooke Masters asks an excellent question in this morning’s Financial Times (link below, subscription required) in the wake of the collapse of FTX and the Theranos scandal: doesn’t anyone do due diligence anymore?
In my time as a lawyer, I have seen the scope and intensity of due diligence (or DD) exercises change, with a noticeable trend towards “lighter” investigations.
This is not hard to explain. Due diligence can be time-consuming, costly and tediously repetitive. For many an investor or trade buyer keenly seeking to deploy unused capital, it can feel like wading through a stamina-sapping swamp. If the excitement of incepting a deal mirrors The Fellowship of the Ring, and the surge of achievement on completion channels The Return of the King, due diligence can test one’s patience in a way only The Two Towers does.
(Personally, diligence was always my favourite stage of a transaction. I would transform myself into a legal sleuth, spotting clues to risk and hints of problems, following trails until I uncovered mysteries hidden deep beneath piles of documents, often deliberately made huge to mislead and misdirect.)
DD can also be expensive and seem poor value for money when, for whatever reason, a deal aborts – time and energy invested into a proposition that lingers ethereally for so long but fails to materialise.
But due diligence is important. No – it's critical.
The allure of saving costs and moving quickly can tempt investors into cursory investigations that fail to surface fundamental and systemic issues within a potential investment. As FTX shows us, businesses can – and do – fail for a variety of reasons.
Through DD, an investor can identify opportunities to remediate problems, mitigate risks and challenges, and perhaps even improve processes and profitability. If nothing else, well-conducted diligence can help to avoid potentially catastrophic investment decisions.
Remember, too, that there is no “one size fits all” approach to due diligence. Investigations can range from a full-blown, in-depth analysis of every last contract and line item to a high-level appraisal of key aspects of a business (what we often call a “red flag” exercise). Experienced legal, accounting and financial advisers can help to guide an investor towards the approach that is right for it.
And, even when an investment doesn’t proceed, we can still learn from a DD exercise.
Every investigation is an opportunity to understand why a particular business is (or isn’t) successful. To identify essential problems to be unearthed in the future but which were not contemplated last time round. To hone our skills of investigation and appraisal. To take away knowledge that can enhance our own business and operations. To work closely with colleagues and advisers to build a collaborative team ready to be deployed on the next investment.
Skimping on due diligence can risk robbing Peter to pay Paul. As the old proverb states: in prosperity, caution; in adversity, patience.
Due diligence once meant sending bankers to check that a mining company really had a working gold mine, hiring accountants to scour the books and asking lawyers to identify contracts that could prove troublesome in a bankruptcy.
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