Why Due Diligence Should be Like a Home Inspection

When you buy a house, even though you think of it as a home, it's also a long-term investment. Both from the standpoint of being a place to live and from a financial standpoint, you want everything to be right. Similarly, and even more so, when your company is buying another company, you want everything to be right. While you would like for everyone on both sides of the deal to be happy, it's purely a financial transaction.

If you were hiring a home inspector, how would you go about it? If you were prudent, I think you would want references not of how an inspector wrote a nice report, but about problems that he had found that either resulted in purchase price adjustments, things getting fixed before the deal closed, or even killed a deal. The alternative is that you get a nice guy who doesn't want to stir the pot and cause problems. He won't cause problems, but you will get stuck with the problems.

Due diligence when doing a corporate acquisition should be the same. Unfortunately, oftentimes, it is not.

Companies about to do an acquisition usually (in my experience) do not go through the same level of prudence in choosing their external partners for their due diligence team. So often, it consists of their regular accounting, tax, and legal advisers. Some of them may be excellent, but some may be in a comfort zone with respect to the company. They want the deal to go through. They don't want to be a troublemaker.

If you were to ask me whether I can be a due diligence "troublemaker" or not, that would be easy.

• In one situation, a client was seeking to buy a company of similar size. My review caused me to tell them that the benefit and compensation plans were significantly undervalued and that their true cost was much higher. My client changed their offer. They were not the winning bidder. The winning bidder didn't win either; the deal put them out of business.
• In another, a SERP attached to an employment agreement was worded very strangely. The seller said that it was the same thing that they had given their previous CEO. It sure was a good thing that somebody put pencil to paper, so to speak, to determine the cost of a change-in-control. Once the deal is done, there is not much leverage to go back and negotiate.

So, which home inspector are you going to engage? Who do you want to have performing your due diligence?