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What is a Due Diligence Investigation

“Due diligence investigation” is a phrase that varies in meaning among different business organizations and industries.

From the perspective of a venture capitalist or a private equity investment manager, it’s about assessing the business model, conducting market research and talking to the market.

For an accountant, it may be analyzing the books and records.

From an investigator’s perspective, a due diligence investigation is utilized to assess the character, integrity and reputation of potential business partner(s) or key player(s) in a venture before the client enters into a substantial financial relationship.

What is a due diligence investigation?

A due diligence investigation is conducted to assess the qualifications and track records of the people involved in the deal, to identify potential inconsistencies, misrepresentations, omissions or controversies in their backgrounds.

When is a due diligence investigation performed?

These investigations are commonly performed prior to transactions such as a merger or acquisition, formation of a business partnership or strategic partnership, or a significant investment or financing arrangement.

Who requests a due diligence investigation?

Due diligence investigations are typically conducted on behalf of small and medium-size businesses, large corporations, investment banks, private equity firms or other investors. In many cases, the investigation is initiated by a legal team involved with the deal in order to protect the integrity of the information.

What is included in a due diligence investigation?

Information that is typically covered in a due diligence investigation includes the following:

  • Personal and professional history, which includes work history, board memberships and nonprofit affiliations
  • Historical news media research on the individuals and businesses with which they have been affiliated
  • Details of civil litigation and criminal case history, including on-site court research and retrieval, where applicable
  • Regulatory records, professional licenses and government compliance checks
  • Financial history, which includes personal assets, judgments, liens, bankruptcies and U.S. Tax Court cases
  • Corporate affiliations, sex offender registries, driving history records and political contribution records
  • Credit history (with consent)

In addition to the above, a due diligence investigation can include interviews with references, sources or relevant parties.

What kind of information is found in a due diligence investigation?

Some of the more common issues that are revealed in a due diligence investigation include the following:

  • Misrepresentations of employment history or falsified degree information
  • Financial troubles, including bankruptcies, tax liens and foreclosures
  • Accusations in lawsuits, such as harassment or fraud
  • Regulatory issues
  • Past criminal trouble, including drunk driving
  • History of litigiousness
  • Undisclosed corporate affiliations, government scrutiny or a trail of failed companies

Why conduct a due diligence investigation?

In today’s business world, information is power. In the end, the purpose of conducting a due diligence investigation is to gather as much intelligence and information as possible to help you make a more informed decision.

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Family Office Due Diligence Background Checks

A due diligence background check on potential investments can help your family office preserve wealth and protect assets for generations to come.

Frauds, Ponzi Schemes and Financial Fraudsters

The news is filled with stories of some of the most sophisticated investors in the world being duped by investment frauds, Ponzi schemes and financial fraudsters.

While institutional investors have been splashed across the news for their lack of due diligence and background checks, in truth, it is the smaller family offices and wealthy individual investors who have been most affected. For institutional investors, losses can be more easily absorbed, but any losses sustained by a family office from an investment fraud can affect generations of family wealth.

A recent poll by Rothstein Kass Family Office Group found that 85% of single-family office operations are currently invested in hedge funds.

The fact of the matter is that fraudsters prey on wealthy individuals, family offices, endowments and even nonprofit organizations because they know that they do not have the same due diligence resources as institutional investors and are less likely to perform a due diligence investigation. As financial frauds have become prominent, so too have the services of professional investigative firms to uncover potential issues and minimize investment risk.

What your family office could have avoided with a due diligence background check:

  • Sam Israel (Bayou Fund) – In 2005, Sam Israel was charged with losing more than $400 million from investors in the Bayou Fund and was sentenced to 25 years in prison in 2008. A due diligence background check on Israel and the Bayou Fund would have identified multiple red flags, including embellished employment credentials, an accounting firm that had ties to Bayou’s own chief financial officer, and DUI and criminal possession of a controlled substance charges against Israel.
  • Samuel “Mouli” Cohen – In August 2010, federal prosecutors in California unsealed a criminal indictment accusing local businessman Samuel “Mouli” Cohen of defrauding more than 55 investors, including actor Danny Glover, out of more than $30 million. An investigation into Mouli Cohen would have identified previous failed business ventures, prior allegations of fraud and nearly $500,000 in back taxes owed to the government.
  • Danny Pang (PEM Group) – In 2009, Danny Pang, the principal of a $4 billion international investment firm, was accused of defrauding investors of hundreds of millions of dollars. A background check would have revealed that Pang was misrepresenting his education credentials, his property was in foreclosure five years prior to charges being brought against him, and multiple civil lawsuits including harassment charges were filed against him.

Final Thought

Don’t become another statistic. Due diligence background checks can help you minimize your risks, protect your assets, make more informed decisions about your investments and protect assets for generations to come.

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Due Diligence Background Investigation for Private Equity Firms

One of the most overlooked areas in a private equity transaction is a due diligence background investigation on the key players or principals part of the transaction.  The purpose of the due diligence background investigation is to evaluate the integrity of individuals – both personally and professionally – that you are going to be doing business with. Understanding the personal and professional history of those key players can be the difference between a successful transaction and a complete failure.

People are Assets

In some cases, the key assets that are being acquired as part of an acquisition are hard assets such as a product, factory, patent  or even an idea.  But in other cases, the most important assets are the people that are going to be on board, especially in service related businesses.  If the transaction involves the acquisition of key principals that are going to be the foundation to the future success of the company, among the key issues that need to be answered as part of the due diligence investigation process is the background and reputations of the parties whom you will be doing business with.

Key issues that could be uncovered:

  • Business Interests – Corporate executives engaging in self-dealing or previous business interests that have been the subject of controversy, bankruptcy or sanctions
  • Personal History – Multiple divorce filings with allegations of personal misconduct
  • Professional History – Falsified education credentials or misrepresentations of previous work history
  • Regulatory Issues – Undisclosed regulatory complaints or disciplinary actions taken by state or federal regulatory agency
  • Criminal/Civil Cases – Multiple convictions for driving under the influence of alcohol, allegations of soliciting a prostitute or litigious past
  • Financial Status – Hundreds of thousands of dollars in federal tax liens, credit issues to grievances filed with U.S. Tax Court
  • Assets – Multiple houses and boats which could show someone living beyond their means

In Depth: Anatomy of a Comprehensive Background Investigations [Infographic]

Who should a private equity firm conduct a due diligence background investigation on?

To best answer this question, some of the key questions that you need to ask yourself is: how much capital is at risk, how much reliance is being placed on the key principals of this transaction and the nature of the business (a paper mill and an oil exploration business have two totally different risk profiles). Ultimately, it’s a choice that the private equity firm must make, but at the very least, a due diligence background investigation should be conducted on the key principals as part of the transaction, specifically those individuals whom you have identified during the transaction as keys to the future success to the company.

Final Thought

Having the wrong management in charge can be the  difference between an immediately successful acquisition or a complete failure. The goal of the due diligence background investigation is to identify relevant issues in management’s background and track record to make a well informed business decision that could impact your investment decision.

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