K2 Global Consulting

Under the doctrine of caveat emptor (“let the buyer beware”), the buyer cannot recover compensation from a seller for defects on a property that renders the property unfit for ordinary purposes. The only exception is if the seller actively conceals latent defects or otherwise makes material misrepresentations amounting to fraud. K2 Global is seeing more and more of these exceptions in today’s corporate world– acquisitions where buyers, once taking ownership of a new property, entity, or business, suddenly find out that they’ve purchased more (or less) than they’d bargained for.

But what are the steps a company or an individual should consider when performing due diligence surrounding a potential acquisition? The first thing to consider is performing a thorough investigation and due diligence before acquiring a business. While this seems fairly obvious, we have seen companies wait until the money is spent and the acquisition is complete before realizing there are issues they weren’t aware of.

Our approach to due diligence is to take a step beyond the routine due diligence, which  will uncover the obvious “warts” of a company, and perform a deep dig that will ensure that your investors, Board of Directors and management of your company will be acquiring assets and not surprises.  Our due diligence model requires an acquiring company to understand that asking questions of the existing management is not enough. Sure, they will provide the answers you expect but are they the right answers? Are they the complete story?

A thorough due diligence must poke, prod and above all else challenge what management says concerning the major issues affecting the acquired company.  It requires examination of the issues uncovered from various perspectives, which is why our due diligence teams are comprised of experienced investigators from a variety of fields (from securities lawyers to forensic accountants to business intelligence professionals).  As for the issues themselves, we believe a thorough due diligence, whether performed before an acquisition or before sinking additional funds into a venture, should evaluate several key aspects of the company including financial, legal, controls, technology and reputational risk:

Let’s start with financial. In order to thoroughly review a company’s financial stability, it’s essential to address the following questions:

- Are the accounting records up-to-date?

- Have there been concerns raised by internal or external auditors concerning weaknesses in the financials?

- What do the accounting policies and procedures look like and how long have they been in place?

- Have they been consistently enforced by senior management and applied to all employees?

Sufficient accounting policies support the achievement of the company’s objectives and operational effectiveness.

Conversely, accounting issues raise the possibility that there are not adequate controls in place to reliably identify material misstatements in the company financials. This can further undermine the Board of Directors and senior management’s ability to enforce and supervise issues affecting the company’s financial stability.  Any or all of these issues can lead to a lack of transparency concerning the state of the financials as well as material misrepresentations to investors.

Due diligence is a layered and complex process, so there’s more to talk about. In my next post, I’ll explore how we approach an acquisition target’s legal liabilities and controls.