A few months ago, I looked at an interesting deal. The product had great
features and the company was showing lots of strength in terms of revenues.
Looking at the initial due diligence materials, I read through the bios of the
management team. With a quick check of the Net, I found out that the CEO had
recently signed a consent decree with the Securities and Exchange Commission
(SEC).
I asked him, "Why didn't you disclose this?"
His answer was, "I didn't think it was important."
It was, of course, very important. This is not to say that it was a deal
breaker. However, if a transaction begins on a note of duplicity, it can easily
kill a deal.
In due diligence, it is often the case that the buyer will go through a long
checklist that covers such things as corporate structure, the financials, legal,
and so on. Interestingly enough, an often neglected area is background checks on
the key principals of the selling company.
This can be a big mistake, of course. As we have seen over the past few years,
no company is immune from shenanigans or downright criminal behavior.
In fact, there are many cost-effective services that can perform background
checks, such as US Search (www.ussearch) and KnowX (www.knowx.com).
Moreover, with the power of the Internet, it is much easier for a buyer to
conduct his own background check.
What are some of the techniques you can use? Let's take a look:
US Patent & Trademark Office (www.uspto.gov/): In one business plan I reviewed,
there was a mention of a patent on the company's technology. So, I went to the
US Patent & Trademark Office's Web site and searched their database. The patent
did not exist.
Ask the other party for the Patent number. Then you can search the database at
www.uspto.gov/patft/index.html.
Securities and Exchange Commission (www.sec.gov): The SEC has a section that
includes enforcement actions. This is how I learned about the consent decree
described in the story above.
Also, you can search the EDGAR database on the site. This has most of the
required filings for almost ten years. You can learn about the different
companies an officer or director has been a part of. Did they sell a lot of
stock? Is the company still around?
You can find the enforcement actions at http://www.sec.gov/litigation.shtml.
Federal Communications Commission (www.fcc.gov): The FCC regulates a variety of
commercial practices. An important area is marketing. At the FTC site, you can
search to see if the individual has been sanctioned for illegal marketing
activities. http://www.fcc.gov/searchtools.html.
Attorney General's Office: Each state has an attorney general's office. The
federal government also has such an agency. And both pursue criminal violations.
You can find state agencies at http://www.naag.org/ag/full_ag_table.php.
National Associations of Securities Dealers Regulation (www.nasdr.com): The NASD
regulates the securities industry. If you want to learn more about another
investment banker, this site may be of help.
The location for the database is http://www.nasdr.com/1200.asp.
Better Business Bureau: Each state has a BBB. From this agency, you can learn
about customer complaints. Here is a resource: http://search.bbb.org/search.html.
Google.com: Of course, this is a tremendous search engine. I have found lots of
useful information, especially newspaper articles that provide reputational
information.
Paid Services
While the above techniques are helpful, they are far from foolproof. It is not
uncommon for Internet resources to have errors. Also, the Net is likely only to
have a part of the background information needed. That is, you will likely use a
paid service.
The information you can get from such a service include:
Criminal violations
Liens/bankruptcies
Credit history
Litigation
Business media
However, before making conducting a paid search, it is important to get the
consent of the person involved, so as to avoid privacy problems. A good idea
would be to have a separate consent agreement or a clause in an engagement
agreement.
What if the person does not provide consent? Well, this could be a sign that
there is something to hide.
Also, premium search services are affordable. For example, with US Search, the
following is the price structure for a routine background search:
$70 - Business Credit Report (company's ownership, payment history, bank account
balance, credit risk and so on)
$20 - Court Record Search (Liens, judgments, and bankruptcies)
$59.95 - Nationwide Criminal Search (US Search gets its information straight
from the county court houses)
Conclusion
So, at a minimum, make sure you conduct online searches on the principles of the
deal. And it is also a good idea to call references.
Yet, this is no guarantee. A famous case was the merger between HFS and CUC
International. CUC got reference checks on the CEO that included Bill Gates,
Warren Buffett and Henry Kravis. All had glowing reviews of the CEO.
The CEO, it turned out, was a brilliant con. He had been fabricating the
company's profits for about ten years. It was not until CUC closed the deal that
it found out about the sham -- resulting in one of the biggest M&A fiascos in
history. Nothing is perfect. But, with routine background checks, you can
certainly help mitigate unnecessary risk factors that can wreck a deal.
MergerPlace is pleased to have the esteemed Mr. Tom Taulli as the
managing editor of our MergerPlace M & A Advisor™ E-zine.
Tom has been quoted extensively in the press, including the Wall
Street Journal, USA Today, Barron's, and The Los Angeles Times, and has
provided commentary on CNBC, CNN, and Bloomberg TV, as well as
appeared on a variety of top radio stations across the country.
Tom Taulli is an expert in the M&A process. He is the author of the
critically acclaimed The Complete M&A Handbook (Random House) as well
as six other books written for publishers such as Bloomberg and
McGraw-Hill. Tom also teaches M&A at the USC School of Business.