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When Diligence Doesn’t Get Its Due

By January 27, 2023No Comments

“How many more questions is he going to ask?” said a business broker to me about a buyer doing thorough due diligence. My answer was probably something like, until he’s sure it is what you say it is.

I first saw it in the Wall Street Journal and then in the New York Times, which did a long expose on JP Morgan Chase getting swindled when they bought Frank, a (supposed) college financial aid service company for $175 million.

There is now a lawsuit, a countersuit, a claim that 70% of customers were fake, and much more. I asked ChatGPT to give me a list of the top 10 due diligence items in business acquisition and number two on the list, just after financial analysis was:

Evaluating the target company’s operations, including its management, employees, suppliers, customers, and production processes, to assess its efficiency and effectiveness.

See it right there, evaluate the customers. People familiar with the college financial aid process say the things Frank stated they could do and at the price they would do them for wasn’t realistic. So what happened? In my opinion, people at JPM Chase got “Buyer Fever.” They thought they could make a killing and instead became roadkill.

They were basically buying names and one must wonder why they didn’t:

  • Verify customers before closing on the deal.
  • Take a step back and see if revenue per customer ratio made sense.
  • Assess the costs to convert young financial aid students to long-term Chase customers.

Business sellers often get frustrated with the questions and data requirements from a buyer. Which is why good seller preparation includes:

Making sure the seller understands it’s open kimono time, everything is disclosed. It seems Chase didn’t ask for the kimono to be fully opened.

The buyer will ask the same or similar question more than once. Sometimes because it’s like taking a drink from a fire hose and other times it’s to see if they get the same answer. If you don’t ask the question once, you sure aren’t asking it twice.

Just when you think you’ve answered every possible question the bank or investors will ask more. I’ll bet Chase’s frontline people perform more diligence on loans under $10 million than their executive suite people did on this acquisition.

Years ago we modified a diligence tracking form a buyer was using. Our template is broken into 17 sections (financial, employees and management, operations, etc.), it’s color coded, it notes who is provide the information, and in what format (spreadsheet, tax return, discussion, etc.).

Some topics, like market conditions and marketing are long. Others, like insurance, can be covered by providing policies and claims records. It goes to buyers we work with, and we share it with seller clients, so they know what to expect.

And here’s part of the secret sauce. We encourage the buyer and seller to cover one or two topics a week and stick to those topics. Keep the meetings or calls short so there’s no burnout and remember the seller is still running the business. It’s also the start of the transition and learning process.

There are more due diligence lists than any buyer would want to use, than any seller would like to answer, and this is not about analysis-paralysis. It’s to make sure what it is what the buyer thinks (and has been told) it is.