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Face the Facts.

Merger negotiations were going well. The acquiring company was carrying out its due diligence on the accounts. Everything was shaping up for final signature, except that due diligence on revenue streams, accountancy systems and stock levels had missed one rather material point – the CEO had criminal convictions for fraud.

The acquiring company discovered the information in time to abort the merger, but the incident reveals a key danger in due diligence exercises.

They might be missing facts about the directors or management team that have a significant bearing on whether to make the acquisition or not.

In many cases, the due diligence process fails to cover enough about the background of key personnel. CVs are treated as the gospel truth.

It doesn’t make sense to Bob Dulieu, operations director of risk and investigation services plc Capcon Holdings. “When you’re acquiring a business, more often than not it’s the people you’re acquiring who will be key to its success,” says Dulieu. “It’s important to take a closer look at the people, their background, reputation and any business issues from their past that may be relevant.”

So far this year, his investigators have uncovered skeletons in cupboards that have sunk three deals, and it could be that more are slipping through in M&A deals because due diligence of key people isn’t a priority. “We’d like to see it done all the time,” says Dulieu. “In fact, it’s something that only tends to come up when there’s an issue.” In practice, key people due diligence only happens when something sets the alarm bells ringing.

Some of the stories from Dulieu’s case file are enough to make an FD’s hair stand on end. In one case, investigators found that the principal of a major company seeking to raise a large sum of money was, in fact, suspected of money laundering by European enforcement agencies. Worryingly, the individual in question had already been cleared.

In another case, investigators discovered that a plc FD had made fraudulent claims on his CV. Checks with the professional institutes revealed he wasn’t qualified as an accountant.

But in some cases, due diligence actually disperses the fog of suspicion. Before an important flotation, rumours started circulating that the company’s chairman, while working for a previous company, had been the focus of a DTI inquiry and a Serious Fraud Office investigation. Dulieu’s researchers found the chairman had, indeed, been named in a DTI report but had never been a suspect for the SFO.

Often, a starting point for Dulieu’s team is consulting public databases and records. Press reports are an important source of information. “We may look at an article in the press that came out four or five years ago, but, as often as not, there is a story behind the story,” says Dulieu.

“Some press reports are placed by public relations people interested in presenting their clients in the best possible light.”

There are other traps in this type of work. One is making sure the person named in a media report is the same as the person under investigation.

Above all, it is vital that due diligence is carried out according to all relevant laws, such as the Data Protection Act.

Even so, Dulieu admits that key person due diligence can be carried out covertly. “It depends what stage the proposed deal has reached. It may be pre-deal screening, in which case the target will not yet be aware that somebody is planning a takeover.”

Alongside public sources of information, Dulieu’s team may also interview relevant industry figures who’ve worked with the people under investigation in the past, or former business colleagues.

It’s not the job of the investigators to make a judgement on what they find, says Dulieu. “We just present the facts to our clients and leave them to decide what course of action they want to take.” Skeletons in cupboards can prove costly.

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