Do Your Due Diligence

Dec 3, 2009

No, the law doesn’t require it, but neglecting to do your due diligence could be among the most regrettable episodes of your life-I’ve seen examples firsthand.

Now that I have your attention, perhaps we should explore the expression due diligence, a term I heard for the first time a few years ago when I was selling a small business to a much larger company-a company with attorneys who didn’t make acquisitions without first doing their due diligence.

A Calm, Collected Approach

Although a dictionary may define it in other terms, I like to think of due diligence as being a “thorough and skillful cross-examination of the seller’s testimony in order to verify facts or expose fraud.”

Another definition might be “a thorough investigation into, and analysis of facts willingly revealed or independently discovered by the investigator.”

The truth is that some sellers will lie, or at least grossly misrepresent what they are selling. Of course, it is also true that other sellers won’t. But even those in the latter category may have incurred encumbrances or liabilities that they may not even be aware of that you, as the new owner, would then assume.

I once attended a SBA seminar during which one speaker related multiple horror stories of entrepreneurs who took it very hard on the chin, in the shorts, in the pocketbook and through the heart, because they didn’t investigate claims before buying.

Although they were unfortunate, they were also unwise. How so? To borrow an expression from some of my car salesmen associates, they went under the ether and made a commitment while overcome with emotion and anticipation.

That’s not hard to understand when you consider that many of those above-mentioned cases involved inexperienced people who were entirely uneducated as to the realities of starting, building and/or maintaining a business. Like me, they had probably never heard of due diligence.

Another lesson I’ve learned comes from a fleet salesman I know. He explained that two of the most powerful forces motivating a buyer are greed and fear. Greed needs not be explained-the buyer wants to get rich quickly. Unfortunately, he may be taken advantage of just as quickly.

But how is fear a liability to the buyer? The seller may have you thinking that you have to act now or you will lose out. Or, he may persuade you to believe that all other competitors are somehow badly inferior when that is, in fact, not the case.

I know of one scam where a company selling reconditioning products would call a dealership to find out who its reconditioning vendors were. A rep would then call each vendor and promote his vastly superior product. To harden his pitch, he would warn that if the vendor didn’t buy his products, he would sell directly to the dealer so they could bring the service in-house, costing the vendor his account.

I encountered this company at a trade show a couple of years ago under a new name [a real red flag]. They saw from my nametag that I was from Denver and immediately warned me that they would soon be “hitting the Denver market real hard.”

Well, that was some years ago, and I have yet to encounter them here. Fear may induce you to act too quickly to sufficiently conduct your due diligence.

Cut Through the Hype

Let’s assume that you are already a professional, not given to naivety, greed or fear. What kind of factors might you consider while conducting your due diligence?

It doesn’t even have to be something substantial, like a franchise. It could be, say, a course on a specific reconditioning service. It shouldn’t be difficult to find out if a franchise is legitimate. The franchiser likely has to be registered with either his or your state government.

If you are dealing with a licensor, however, there are lots more potential deceptions. Is there real intellectual property involved, or is it all blue sky or smoke and mirrors? If it’s patented, then the patent is on record. If you are told the patent is pending, then I bet it isn’t. [I have a patent, and it’s a relatively short period between when the patent office informs you that the patent will be granted and its actual issuance.]

Simply being applied for doesn’t mean its issuance is assured. And even if something is patented, that is not necessarily important.

Another lesson that rises from the smoke of smoldering hype and baloney in our trade is that even though all that is significant is true, many hyped things that are true are not necessarily significant.

If you are pitched a business opportunity by a company out of state, are they registered with the government in your state, if obligated? Can they prove it?

Or, are they trying to sell something you can easily obtain through other, less costly sources? Can you verify reputations? Sure, they may have testimonials, but who doesn’t? They may well be provided by someone with a serious conflict of interest.

Another factor to consider is if a product or process is a good buy now in what is, for some, a diminishing market. I know what this statement suggests.

In my case, being an established painter in Denver, business is very good, perhaps the best ever. But even so, my customers are not selling as many cars as they used to. What has benefited me is that the pretenders who may have done well financially while producing marginal work [or worse] are now being fired by customers who realize that the work they pay for has to be justified.

Someone probably could, and possibly has, written a book on how to do effective due diligence. But just being aware not to take everything you hear at face value is a start.

Common sense helps, as can a lawyer, a SBA counselor, or someone like me who has been there, done that.