Due diligence…sounds boring. Really who wants to get stuck in a room with paper work, accountants, lawyers and other advisors pouring over the records, looking at the products and otherwise tearing apart the new shiny business your heart is set on?
Due diligence may be hard work, and may seem painfully tedious, but the downside of not performing due diligence can be catastrophic.
Let’s imagine for a moment, we are looking at a reticulation retailer. We look at the business and the seller show us a set of glossy sales figures, lots of profit and a really exciting margin. Not knowing anything and without seeking advice we get all excited as we envisage new cars, overseas holidays and so on. This vision nags at us and a confirmation bias kicks in, as we are only human. Next thing is we are parting with our hard earned for this shiny vision.
We take possession of the business and the old owner walks away. Within a short period, there is something very wrong. The number of sales are significantly lower than the financial records indicate. In fact, within only a few months the turnover is less than half of what we were shown and thought we were purchasing. Appropriate financial due diligence would have revealed the issue and we would have known what we were actually buying.
That’s not the only area where we may get stung. In the same scenario the owner walks away and in a few months, things are going as promised, however suddenly out of seemingly nowhere the landlord serves us a notice to vacate. The building in which the business operates is about to be demolished and we need to move to a less than ideal location. Again, due diligence would have found the impending end of lease and enabled exploration of the issues prior to parting with the investment.
Imagine for a moment another scenario…our small reticulation store is named Irrigation Bushies Machinations, or IBM for short. The business has been named this for perhaps 20 years and has a great reputation. Part of what we invested in is the name, the legend and history of this long-established retailer. As we didn’t complete due diligence, we didn’t discover there is a passing off action pending… IBM (the company International Business Machines) has served previous notices to cease and desist with respect to using their business name. The previous owner has completed some research and discovered name recognition was responsible for 50% of the turnover and consequently didn’t want to change the name. The choices faced now are to defend the passing off case, which could very well be expensive, change the name and face an immediate drop in turnover, or perhaps worst of all, if this can't be resolved, is to walk away from the business altogether.
In this short article we have considered the potential downside of not performing due diligence. This article can’t take the place of professional advice, however, hopefully helps you appreciate the necessity of those rather boring due diligence discussions the accountant, lawyer or financial advisors have suggested.
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