How diligent is your due diligence?


When buying into in a company any investor worth their salt will undertake some investigation into the quality of the opportunity before them. They do their homework. But are they being as diligent as they could be?

Stages in the due diligence process includes detailed investigation of the key areas of a business: its management team, its finances, its HR practices, its operational competency, its technological prowess and so on. I have come across one or two references to more market-oriented language, but they weren’t exactly unequivocal in whether they nailed down my concerns about whether a business’s offerings to the world are actually founded on addressing some fresh insight into a new problem space and were making a great contribution to competitive advantage.

When you make an investment decision in your personal life, say a new laptop, you take a range of similar factors into account. You think about the people you are buying from (sales staff really know their stuff, and the guys at the technical counter answered all your questions), the value for money it affords (bit more expensive than the run-of-the-mill laptops but a brand with a great reputation), how well it operates (very reliable, the OS never seems to fall over) and how well made it is (build quality is superb: milled from a solid piece of aluminium!).

You also make decisions about factors around how well it meets your other needs, and whether one might better meet them than another (everything is so intuitive and you never seem to lose your way). You take great delight when you realize it also solves a problem you didn’t realize you had (like not having to mouse over to the scroll bar and click and drag to move within a pane, just put two fingers on the mouse pad and your done).

I got all excited when I came across ‘Know Your Customer’ which is “the due diligence and bank regulation that financial institutions must perform”. It turns out that this is not a legal mandate to ensure that the services an organization provides its customers are the most apt in terms of meeting their needs. It’s concerned with ensuring the customer is who they say they are and are not engaged in ‘identity theft, money laundering or terrorist financing’.

So, as a natural companion to the quality of a solution (Technical Due Diligence – TDD), I’d like to make a case for Problem Due Diligence: PDD. At 100% Open, we’d love to help you assess the quality of the problems you are looking at and maybe find you one or two more you hadn’t considered. You never know, you might just find the opportunities that lead you to become known tomorrow for a quality of problem AND solution, as Apple is today (you knew the laptop was an Apple right?).

by David Townson

Comments

  1. This is my opinion based upon what my understanding of what you are trying to say in this article.

    In my experience, almost every major M&A activity involving private equity houses does involve some degree of what’s called commercial due diligence (CDD).

    Most of the time a leading either independent consultancy or one of the Big 4’s Transaction Services teams is commissioned to conduct this due diligence looking at the target’s market, competition and customer base.

    The key thing is to understand the dynamics of the market and whether there will be growth in their niche and then more specifically will their customers continue to buy from them in the next three years. This is a way of ‘checking’ the sales forecasts from management.

    Essentially is there going to continue to be a demand for the target’s offering and how well positioned are they in their customer’s eyes and also versus the competition.

    This kind of CDD is pretty standard although it can vary in depth depending upon time available, complexity, worries about risk and who is commissioning and paying for the research. (E.g. a vendor and a buyer might have different emphases in their research).

    What you are discussing in this blog with a Problem Due Diligence may come across as a bit too ‘wishy-washy’ or vague to the hard-nosed private equity investors who have to prove to their relevant committees or boards why they are wanting to invest in a particular target.

    It is all about in my opinion the hard numbers, historic and future sales, EBITDA etc . I.e. verifiable, quantifiable, exact data. The kind of service you have mentioned may not be able to deliver this as it seems speculative.

    What you are suggesting with PDD – probably comes post-deal in order to try and get some upside to the new vendor. What can they do to get sales above the forecasts from previous management so they can sell for a higher value than which they bought the target.

    It may actually be worth seeing how a PDD service could fit in with CDD pre-deal. E.g. a vendor could use your services on top of the CDD to say this independent consultancy believes there is additional potential with the product or service through innovation.

    This could encourage potential purchasers to push through any doubts because of the potential upside you highlight.

  2. Thanks Rahul. Some great comments there and I especially like the notion of PDD as a way to drive sales further and identify new revenue streams.

    The core point I was trying to make is that thinking about the problem to be solved is as important as any other facet of an innovation (I think it’s the most important personally, as how the problem is framed determines the potential for how innovative or otherwise all else that follows is). And that this should happen as early in the innovation process as possible – and be reflected upon all the way through. But all too often it gets passed over. It’s why we end up with things like the Sinclair C5 occasionally (had loads of investment but, a technical break through in a number of areas but all based on a really bad understand of the problem).

    Spending quality time thinking through the problem before embarking on subsequent activities is a key source of additional opportunity. Albert Einstein is reported to have said that if he had an hour to save the world he’d spend fifty five minutes defining the problem and five minutes figuring out the solution. While we might not have the luxury to spend 11/12ths of our time on problems when practicing as innovators, I think it’s useful to be mindful of the amount of effort being put into understanding the problem. By the time something gets in front of the investors, then it should be a no-brainer that the problem being solved is well understood, but often this is not the case.

    Whether we’d use the term of not, I’d say that PDD should be part of what everyone does – from the back room entrepreneur starting out to the seasoned and successful investor. We probably all need to be a bit more like Albert.

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