The Thinking Blog

What does “real” due diligence mean? (Part 2 of 3)
October 31, 2010

In this post, I want to discuss due diligence for the investor. Yes, the investor must do as much due diligence as possible to insure that he or she is not putting themselves at unnecessary risk before making the investment.

So, to reiterate from Part 1 of this post, our definition of due diligence is the evaluation of all aspects of a business to insure that what you are being told you are buying, is in fact, what you are really buying. Now the word “buying” refers to “buy-in.”

When you are an investor, there are a lot of tools you can use and request that will help you determine whether or not you are being told the whole story. However, I have found that some of the best due diligence is the actual face-to-face meeting with the executives of the management team. When you meet with the team and hear their story, you should be looking for several things.

1. Is the story consistent with what you were told that led you to spending time with the team in the first place? Entrepreneurs often times are so excited (and in some cases, desperate) to get in front of an investor, they will over state the facts. Now, you may be the kind of investor that says, “oh, they just got excited and it’s not a big deal.” You couldn’t be more wrong. You want to invest in a management team that has integrity from day one. If they tell a little untruth now, what will it be when there is a very serious problem. A single little red flag is cause to walk from the deal.

2. To add to the first point, watch the people when they are presenting. Are they comfortable looking you in the eyes? Do they handle questions properly? Most people know when others are lying and so whatever your gut feel tells you, it’s more likely than not, accurate.

3. Request proof of any claims that are made. Examples are: “We have a pending purchase order,” or “we met with Company A and they are wanting to place an order,” or “we have spoken to Mr. Jones at Fortune ABC company and they are sold on the technology.” IF any of these are true, the company should have no problem allowing you to speak to these people to verify the information. There is a way to handle this so that you, the investor, don’t hurt the company’s chance of closing the deal. We cover this in detail in our book, “The Scorpion Factor in Business” which will be released in February 2010. If you get into this situation and need guidance feel free to contact us through www.thinkubator.biz and we would be happy to guide you. Companies seeking your investment capital are in total sales mode with you and it is your job to insure you are not being lied to. Verify, verify, verify.

4. Request the company’s documents. They should have a business plan, a presentation, incorporation documents, by-laws and corporate minutes at the minimum. If the company is selling stock in their company, there should be a Private Placement Memorandum (PPM) and associated documents. If the company is licensing a technology then there should be a licensing agreement. All of this information should be delivered to you in less than 24 hours. If they can’t, regardless of the excuse, it is not a good, organized management team. This may seem harsh, but the reality is, if a company is seeking capital they need to be serious and have their “stuff” together before they get in front of a single investor. Oh, and even if they do produce all of the materials you requested in the 24 hours, you must verify it. Check with the Secretary of State’s office in the state the company is incorporated to insure they are in good standing. Make sure a Licensee is not in default by contacting the Licensor. We have had too many situations where a Licensee was in fact in default of their agreement and did not disclose this to us.

5. Request any and all documents that you need to make you feel comfortable. If you’ve signed the company’s Non-Disclosure Agreement, they should have no problem opening their documents to you. If they do…99% of the time they are hiding something. The other 1% is they are inexperienced and don’t understand due diligence. Either way, it is red flag and cause for walking away.

The bottom line for an investor’s due diligence is quite simple. If it doesn’t feel right, then don’t make the investment. How many times in your life have you gone against you gut feel and things didn’t turn out as you had hoped? Bet on your gut.

Here is to your success.