Outsourcing due diligence offers a number of clear advantages. In an increasingly complex world, retaining the multiplicity of skills in-house required to do meaningful due diligence is cost prohibitive. Consequently, internally undertaken due diligence lacks the investigative skills and well-placed network of specialist providers that can transform box-ticking into something with real investment relevance.
The other crucial characteristic an outsourced provider brings is a complete lack of emotional attachment. Behavioural finance studies show human nature is such that we tend to overvalue data points that reinforce our point of view and undervalue those that contradict it. Consequently, the more time spent evaluating an investment tends to result in the growing resistance to turn it down. How often have you heard a story about an investment breaking down at the eleventh hour when something awful was found out about the CEO and wondered how something so obvious was so easily missed? It is all to do with the difficulties of retaining an unemotional perspective on an investment’s real risks.
Against a backdrop of increasing investment opportunities in emerging markets, rising fraudulent activity and an ever-increasing plethora of regulatory minefields, outsourcing due diligence to a bespoke investigative firm has seldom been more appropriate for the modern, well-run family office. It is cost effective and provides a fresh pair of eyes, which are not concerned with the investment case but with the people involved on the other side of the deal.
Undertaking due diligence is all about mitigating risk and identifying issues which may preclude an investment or deal from going forward, so as to avoid wasted time and unnecessary professional cost escalation. It takes several forms and can comprise a forensic examination of a company’s books, detailed background checks to pick apart a CV or the analysis of a board member’s reputation, track record and probity.
**Past performance**
The need to understand the people behind the investment opportunity is imperative as not only will they be responsible for delivering on the business plan, but their past performance and skills may be even more necessary if things don’t work out as planned.
With skilful presentation and a bit of PR, cracks can be papered over and important facts obfuscated from potential shareholders to mask what is really going on. However, track record, how a company’s management is perceived by its peers, former colleagues and prior investors’ views are more difficult to cover up. By using a third-party due diligence provider to undertake enquiries in a discreet way, relevant insights can be provided and a more informed investment decision be made.
Family offices, discreet by nature, often go to great lengths to be anonymous in their investments but this does not mean basic precautions should not be taken. Instructing a dedicated third-party provider will provide a far higher probability of exposing decision-changing data. There need be no loss of discretion, and in actuality, third-party providers can make enquiries far more easily than those in-house, who would have to say who they are and possibly why they are so interested. The difficulty of having a conversation should not preclude it from being conducted.
In-house due diligence often relies on an automated, subscription database that checks for regulatory infringements, litigation and other negative associations. Such an approach ignores the softer, more human, intelligence-driven research, which provides a truer picture of a company or individual. These database searches cannot be relied upon to offer a rounded and corroborated intelligence picture, based on multiple sources with prior interaction with the individuals involved.
By outsourcing due diligence family offices can avoid many pitfalls and make themselves fully cognisant of the facts before signing on the dotted line.
For those opting to undertake due diligence, Warren Buffett’s dictum applies: it takes 20 years to build a reputation and five minutes to ruin it.
