Introduction to Equity Investment Due Diligence, The Next Generation
Background
Equity investment due diligence covers an extraordinary range, from nothing to the exhaustive. In other words, some equity investments are made with literally no due diligence whatsoever, while others go all the way up to mammoth processes used by many investment houses that run 12-months or more trying to cover every topic imaginable.
In 1984 I started assembling for my own work what is now an immense volume of equity investment due diligence data and information. Among other goals, I wanted to develop a universal set of equity investment due diligence factors. If you look for these factors in the equity investment industry, looking at all the equity investment firms, looking at all the periodicals that touch on this arena, looking at all the books that contain references to due diligence, likewise looking at all the journals… you will not find a set of common due diligence factors. In fact, you will find thousands of different examples of what is termed ‘due diligence’… ranging from the ridiculous, to the mediocre, to the moderate. Here is what is probably the most important financial industry on the planet and everyone has a different view on what constitutes equity investment due diligence. So, equity investment due diligence practices in the financial sphere are different, often quite divergent, even poles apart. Most shocking, there are not any formal scientific qualification or quantification measures for equity investment due diligence (none for due diligence of any kind!).
Even after studying the equity investment industry for decades, I am still dumbfounded at the incredible lack of any sort of a genuine discipline of equity investment due diligence. And what is truly amazing is tacit acceptance that it is ok for anyone to declare what they consider to be due diligence, on whatever basis or lack of basis, with whatever experience or lack of experience!
Now before everyone jumps on me, I am not saying that someone with years of experience doesn’t know how to do their version of equity investment due diligence. There are lots of good people doing equity investment deals, and their version of due diligence may largely suffice for them under current conditions. However, I am saying that everybody’s definition of equity investment due diligence is different and further, at best, most investment firms work from checklists and people power. I challenge anyone to show me a formal, disciplined, well-founded, scientific and universally accepted due diligence system, whether focused on equity investment due diligence or frankly any other due diligence focus. Also, I have yet to find any educational institution offering a course solely dedicated to due diligence, so email me right away if you know of such coursework. In the future there will begin a massive change of thinking when scientific due diligence begins to be taught in the business schools.
In the commonplace reality of today, most equity investment due diligence is done referring to some form of a checklist, usually an amalgamation of the experience of the team members, sometimes coupled with a checklist from a securities attorney. One side note here: If any checklist can be considered valid in today’s equity marketplace, the best checklists I have seen come from competent securities attorneys. Moving on, while checklists are far from an actual due diligence system, undoubtedly it is better to have a checklist than nothing at all. However, without a deep knowledge of each item on a list, especially how all the variations of each item can change for any particular deal, depending on such a list can be quite disastrous.
Also on another side note, fraud investigations and background checks are not due diligence, in spite of so many people’s perceptions to the contrary.
A New Science for Due Diligence
So, in order to build a solid equity investment due diligence system, I had to create a new scientific approach. Among other developments, I organized the incredibly large myriad of possible equity investment due diligence factors by creating a new taxonomy system to accurately systematize all the factors. My taxonomy system today runs to over 100,000 main and sub-categories. Then I created a connections mapping system to differentiate how all these factors can link and associate. Along the way, I created a general system of due diligence with many different sub-systems, including various calculation methodologies, the most important being a scoring system methodology that scores or rates all the factors, including the soft factors, such as the culture of a company. I don’t want to make this article a scientific treatise. However I do think it is important that the reader understand that for the first time there is a solid scientific basis for what constitutes proper equity investment due diligence.
The Next Generation of Equity Investment Due Diligence
So what does the science say about doing equity investment due diligence correctly? The beginning of the process may surprise you. Before you can consider the first equity investment, you have to have a solid footing from which to work. This includes constructing a truly good strategic business plan, and an even better tactical business plan. These are not like some some static document that you toss together once, probably when you put out your firm’s first investment fund offering. These are living breathing roadmaps of your firm’s short and long-term goals that change often, with detailed understandings of how you are going to get there, at what cost, towards what ends, etc., etc. And the tactical plan may change many times per year. If you don’t know where you are and where you are going, how can you know what equity investments to pursue?
Ultimately, equity investment due diligence is about making choices and the consequences arising from those choices. The problems with doing due diligence for equity investments is that often people do not understand the impact of the due diligence on their enterprise, and even worse, they are not aware of every aspect of the due diligence being performed. The key is to make sure that the equity investment due diligence process is properly founded, planned, monitored, and assessed. You must make sure that each step within the process and its related risks are fully developed and gauged. A proper equity investment due diligence process clarifies and provides better understanding of equity investment strategies and tactics, and leads to investments performing at a higher level with less difficulties.
Closing words…
The most important due diligence factor for any equity investment is the people, the human capital. Invest in good people and you will always get a good return. Skimp on the human capital due diligence, or for that matter any other part of a truly complete equity investment due diligence process, and you will end up skimping on your returns.
Charles F. Bacon, CEO & Keeper of the Vision
charlesbacon@superdiligence.com
Due Diligence, Inc.
www.superdiligence.com
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