Outsourcing due diligence offers a number of clear advantages. In an increas-ingly complex world, retaining the multiplicity of skills in-house required to do meaningful due dili-gence is cost prohibitive. Conse-quently, internally undertaken due diligence lacks the investigative skills and well-placed network of a specialist providers that can trans-form box-ticking into something with real investment relevance.
The other crucial characteristic an outsourced provider brings is a complete lack of emotional attach-ment. 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 some-thing awful was found out about the CEO and how was something so obvious, so easily missed? It is all to do with the difficulties of retaining an unemotional perspec-tive on an investment’s real risks.
Against a backdrop of increasing i nvest ment oppor t u n it ies i n emerging markets, rising fraudu-lent activity and an ever increasing plethora of regulator y mine-fields, 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 pairs 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 identi-fying issues which may preclude an investment or deal from going for-ward, so as to avoid wasted time and unnecessary professional cost escalation. It takes several forms and can comprise a forensic exam-ination of a company’s books, detailed background check 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 perfor-mance 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 manage-ment 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 anon-ymous 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 pro-viders can make enquires 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 conver-sation should not preclude it from being conducted.
In-house due diligence often relies on an automated, subscrip-tion database that checks for regu-latory 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 individ-uals involved.
By outsourcing due diligence family offices can avoid many pit-falls and make themselves fully cog-nisant of the facts before signing on the dotted line.
For those opting to undertake due diligence Warren Buffet’s dictum: it takes 20 years to build a reputation and five minutes to ruin it.
