It doesn’t take a private investigator like me to tell you that a fool
and his money are easily parted.
Few people would splash out on a new car
without first taking a test drive, peering under the bonnet, or at least giving
the tyres a perfunctory kick. And failing to research a new home might see
you having to put up with damp, or the neighbours from hell.
When buying a business, operational due diligence is the equivalent of bringing
along a mechanic to do your pedantic tyre-kicking for you, or having a detailed
property survey carried out by someone who knows what they’re doing.
Buying into a bad business could cost your livelihood.
Yet it’s amazing how many businesses will commit to mergers and acquisitions
without knowing the full details of what they’re getting in to down to the
The Royal Bank of Scotland (RBS) found out to their detriment just how
important due diligence can be, when they purchased Dutch bank MBN-AMRO in
2007. Famously, the information the bank gathered on ABN-AMRO fitted into
two lever arch files and a single CD ROM.
Even more surprising than the fact that anyone still uses CD ROMs to store
information, is that RBS bosses were willing to splash out £49 billion on
MBN-AMRO, despite this apparent lack of information.
What the limited research didn’t show was the extent of ABN-AMRO’s exposure to
the sub-prime market, which later resulted in around £20 million in losses for
the RBS, cost chairman
Fred Goodwin his job and led to the bank ultimately being bailed out by the
British tax payer in 2008.
So what could have been done differently?
Whether buying a multinational banking corporation or a local hairdressing
salon, operational due diligence is a series of detailed checks to help make
sure that minor details like toxic debt, poor accounting, or stock
discrepancies won’t jump up and bite a new owner on the behind later on.
Operational due diligence is time-consuming, painstaking work, made all the
more difficult when an intended acquisition is hiding important information to
make the proposition appear more attractive than it actually is - but it’s
important work too.
Thorough due diligence puts every aspect of the business under microscopic
scrutiny. Examining accounts might tell a prospective purchaser that a
business has been performed well in the past and is continuing to make
money. What it might not reveal is that most of the equipment is about to
become outdated and is likely to cost a bailout-sized chunk of cash to replace.
Good operational due diligence can even look into the backgrounds of company
directors and owners to make sure they’re not involved in criminal activity,
give a true picture of asset value and look point out hidden liabilities.
In short, operational due diligence tells you why you might not want to buy a
business. After all, if things do go wrong, no-one is going to bail
your business out.