How many times have you heard about acquisitions that went bad shortly after the deal was signed?

If you are thinking about buying or selling a business or investing in one, you want to make sure it doesn't happen to you.

This is why we always discuss Investigating before Investing. Either you Investigate now or you litigate later.

The best way to protect yourself is to do enough "due diligence" to ensure that you know what you are buying or investing in.

What is due diligence?

Due Diligence is really a form of risk management most commonly known as doing your homework before you invest. "We want to make sure we believe the story before we invest."

The Due Diligence Check List and Investigative Due Diligence

There are a number of forms of Due Diligence. The most common form of Due Diligence is that of the "Due Diligence Check List."

This is a checklist which a corporate lawyer will request that the seller complete prior to closing or making the investment on behalf of the client.

This can be a very small list, or in some situations the check list can be very lengthy and exhaustive. In some cases the list can be up to 100 pages of items to be provided before closing.

Here are just a few examples that might be found on a standard due diligence check list:

Standard Due Diligence Check List

What You Should Be Asking For?

• Letters from Provincial/Federal/State/County government confirming that all tax returns are filed to date with no arrears owing (i.e. payroll, sales tax, health tax and taxes from year-ends).
• Articles of Incorporation.
• Minute Books.
• Shareholder Agreements.
• All Tax Returns Filed To Date.
• All Year-end Reports To Date.
• External and Internal Auditors Reports.
• Letters of verification confirming that all Provincial/Federal/State/County taxes have been paid.
• Letter from Commercial Landlord confirming lease terms and no arrears.
• Powers of Attorney.
• Government licenses, permits, approvals etc.
• Litigation/Execution confirming no judgments, pending or threatened litigation, claims or disputes.
• Listing of outside contractors.
• Loan agreements, lines of credit, debt instruments, notes payable, guarantees (by or in favor of the company), and any other agreements collateralized or secured by the assets.

You may wish to obtain more information on your due diligence check lists, we have a number of samples. Alternatively, it is really best to consult a corporate lawyer.

Investigative Due Diligence

Investigative Due Diligence is a whole different ball game. It is in fact a background investigation on the individual and/or the company.

Investigative Due Diligence can be conducted with or without the knowledge of the individual or the company being investigated. This is your decision to make.

It is perfectly lawful for you to retain an investigation company to conduct a background investigation without anyone knowing about it.

You must first make a decision whether you want to have the owner or the company investigated, or both. Our position is to always do both.
The Owner Of The Company

If you are investing funds in a company, it is the owner(s) who will be responsible for how the funds are spent within the company.

What happens if the owner is in great financial difficulty?

What if there are outstanding lawsuits, judgments, child support obligations and credit card debts? Where do you honestly expect the invested funds to end up first?

The owner may have told his or her outstanding creditors that payment would be resolved once company financing is in place. This could suggest that much of the funds invested will go to paying off personal debts instead of using the funds to expand the company as proposed in the business plan.

In many cases where troubled companies are looking for capital, the owners have exhausted much of their personal reserves. You can expect that paying off personal debts will happen in most of these situations. It is important, however, to know just how bad the debt situation is.

We need to get a rough idea just how much of the investor's money will actually make it into the company.

We also want to find out as much as possible about the past tactics of the owner.

• Have there been other companies owned by this individual that have gone bankrupt shortly after financing was obtained?

• Are there any old or current lawsuits against the owner or the company?
• Has the owner ever been bankrupt?
• Can this owner be trusted ?
• What kind of person is he?
• Does he get on well with employees and managers?
• Is he a proven leader with vision?
• Has this person ever been written up in the media, a trade journal, or an industry publication? Was it a good or bad article ?
• Where does he live? What kind of car does he drive? How much money does he have in the bank? What is the status of the mortgage on his home?

In a recent reported case an owner who had obtained financing for his company was deeply indebted to creditors. The owner did everything possible to get money out of the company and into his pocket.

Numerous fictitious invoices and companies had been created by the owner. The owner wrote cheques to these companies which appeared on the books as nothing more than valid business expenditures.

Thousands went into his pocket through one company name or another. It is the oldest trick in the book.

(Credit Searches, Criminal Records & The Law)

The Controversial Stuff
Two very important investigations to conduct on the owner, in the background stage, are a credit search and a criminal record search.

The credit search is important because it will yield information about the balance on credit cards, collection matters, previous addresses, past employment, the works.

Credit Searches
The Fair Credit Reporting Act (USA), and the Consumer Reporting Act (CAN) make it illegal for anyone to conduct a credit search on an individual without their consent. This means that you will have to advise the owner that you wish to conduct a credit search on him or her or you will not invest.

Just like applying for a loan, it is expected that a credit search will be conducted. It is best for you to draw up a simple written authorization and have the owner sign it. This is a very important search in the investigative due diligence process.

Criminal Record Searches
The law in regard to criminal record searches varies from state to state in the United States. In Canada it is not public record so it is completely illegal for you to obtain a criminal record search on an individual without their consent.

If the owner resides in a location where criminal record information is not public record, you are going to have to instruct the owner to go out and obtain his or her own Certificate of Non-Conviction from their local police station. How to obtain this document will vary from county to county. Inquiries will have to start at your local police division.

If an owner should refuse to give consent in these two areas, your alarm bells should start ringing.

There may very well be a skeleton in the closet.

Unlike the employee and employer relationship, in most investment situations you have the right to refuse to invest for any reason; you may not even have to give a reason at all.

Why Canadian Businesses Fail


What would happen if you were given a key to a race car for which you had only the manual (a written plan), but you had no previous driving experience?

You take your new race car out on to the track and find yourself surrounded by other race car drivers on fast moving track. You try to follow the manual (your written plan), but you discover it?s useless without practical driving experience.

Within moments, you crash into a wall and bring down other race car drivers with you. You suffer injuries that affect you and others for a very long time.

Banks, lenders, and business development organizations wonder why new start-up businesses in Canada continue to crash into the wall at record rates.

Even with the most perfect written business plan, many lenders no longer lend to new start-up businesses simply because the risk for failure is too high.

A friend of mine was recently laid off from a job she had for many years. Like most people she went on unemployment benefits while she struggled to look for work.

Realising her hope for employment in Canada was bleak she decided to start her own business. She had no previous experience running a business.

She discovered a government-sponsored program that would allow her to receive unemployment benefits while starting her own business. The only catch to the deal was she would have to attend and complete the unemployment business training course on how to properly start her own business, or her unemployment benefits would be cut off.

While taking the class she came to me almost weekly seeking help with her business plan. I soon realised that her course was very focused on the written business plan, with very little practical training involved.

Every business scholar and successful entrepreneur would agree that a written business plan is crucial to the start-up process.

Before a building can be built there has to be a solid blueprint. Essentials to a business plan are strategies such as the mission statement, target market, industry analysis, competition, marketing, financial projections and so on.

There is, however, a limit to what can be learned in a classroom setting, without hands-on experience or through the examples of successful entrepreneurs.

If government lenders, banks and others continue to focus exclusively on well-written business plans, they might as well attach a bankruptcy application form to each loan application.

There are many reasons why businesses fail, and in most cases failure has little to do with not following the actual business plan.


CANADA?S BUSINESS TAX SYSTEM

A new small business owner may not be properly prepared to handle Canada?s tax system.

After a year or so in business, the owner can expect government envelopes to begin arriving almost daily in the mail.

All levels of government will be looking for their money. There will be Municipal, Provincial and Federal taxes, plus GST. If your business qualifies you may also be subject to Retail Sales Tax and Workman?s Compensation dues.

Hiring an employee or two will launch the new business owner into Canada?s complicated and expensive payroll system. Many business associations continue to lobby against Canada?s excessive business payroll tax.

They maintain the expensive payroll system alone is prohibiting new start-ups from providing job opportunities. They say this is the true reason why there are few jobs available in Canada. Entrepreneurs simply don?t want to do business here because of our tax system.

A business owner can expect that more than 50% of every dollar earned will be paid out in tax. This means the tax man is your partner and you may not even know it. That is of course if you?re a business that actually pays tax as many don?t. If you do you may find yourself competing with competitors undermining your prices whom have given up and illegally joined the underground economy.

Understanding Canada?s business tax system and how to manage and pay business tax on time can make the difference between success and failure.


Other Challenges

And what about other aspects of business that may not be covered in the business plan? For example:

? Renting space; dealing with commercial landlords who seek long term leases with hidden personal guarantees that may prevent your business from growing when you can?t break out of a lease.

? financing equipment and vehicles successfully

? finding the right insurance for the business and its employees

? Coping with suppliers or customers who don?t pay.

? Dealing with bad debt, insurance claims, lawyers, accountants, customs and freight brokers.

? entering into contracts

? Learning how to hire and fire employees, and discovering their rights under the employment legislation

Some of these issues alone are documented business killers.


What is the Answer?

In the early days of the Internet there was a Dot Com Venture Capital boom. Millions of dollars were being invested by Venture Capitalists and private lenders into new start-ups. Some deals went well; others were disastrous.

During this time, I read about a few Venture Capital firms who made the decision to nurture the business in which they were investing on many different levels.

For example, the new start-ups were not only well-financed by lenders/investors, they were provided with office space sometimes in the same building as the lender or on the same floor.

The owners and staff were given basic business training paid for by the lender/investors. They virtually had a professional venture capitalist holding their hand each step of the way.

Imagine one of Canada?s leading banks lending to new start-ups under a new training program. Before a potential loan applicant could even get an appointment to see a loan rep, they would have to complete a joint government and bank sponsored professional business course.

A course available day, nights, or weekends to accommodate any schedule, taught by qualified business professionals who were not only teachers but were successful entrepreneurs in their own right.

Entrepreneurs who focus not only on the written business plan but who could teach on all the expected struggles of running a Canadian business. A course that could cover various aspects of industry, such as retail, construction, manufacturing, technology etc.

In Canada we have subsidized housing for those who cannot afford to pay expensive rent. Imagine government-subsidized commercial space for new businesses trying to grow.


Why should we expect the government to pay or assist with such training?


Every new business created is a new tax payer to our system. A company who will pay the government 50% or more on every dollar earned. Each employee who works at the new company will also pay an array of other taxes. An employee who is making money will also spend money into the economy.

The failure of a company, from a government standpoint, is the death of a tax payer. It is in the government?s best interest to keep businesses alive and offer incentives for business to be created and to grow, so that jobs can be created.

Giving out government grants to new start ups using well-designed business plans to the untrained and unqualified only increases the financial coffers of bankruptcy trustees.

Note:

If your business failed in Canada, we would appreciate you telling us your story via our feedback of this blog.

We continue to research and set up programs to help businesses grow and prevent them from failing.


The Author:
Kevin Bousquet is the president of The Corpa Group Inc; a Private Investigation and Due Diligence firm working for the Venture Capital Industry.

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Scams To Watch For (If you are seeking investment)

If you use a company or a middleman such a loan broker to try to find you an investor or a venture capitalist, you may be asked to pay a large fee up front before any financing has been obtained.

This advance payment may be called a processing fee, finder?s fee, or credit application fee.Prior to being told about the up-front fee, you will be put through an exhaustive array of frustrating paper work which will include credit applications, the business plan, references, co-signers, numerous interviews, etc.

Even though you have been told the fee is completely refundable, you may have trouble collecting your refund through the court system if the middleman has no assets.You should be aware that there are thousands of fraudulent companies and fraudulent middlemen who make their living scamming for these processing fees. The agreement between you will be so fine that you may find yourself in the cold as a result of some unconditional clause in the contract.

There are hundreds of reasons why you could be denied independent financing under the contact.This processing fee scam has gotten so bad there has been new legislation written in many States and Provinces to protect consumers from it. This type of scam is most commonly found in the mortgage broker and loan broker field.

I could write a book on the number of mortgage brokers I have investigated in my career.If you are using a middleman you must check references. Have them give you the name of 10 to 20 individuals for whom financing has been successfully obtained. Pick up the phone and call these individuals.

If you are nervous about paying the finder?s fee, pay the fee to your lawyer in ?trust.? Your lawyer will disburse the finder?s fee only when the financing is in place. Just have your lawyer write the middleman a letter confirming that his fees are being held in trust upon completion of financing. It must be your lawyer, and not the lawyer acting for the middleman.

There are a number of legitimate middlemen out there who work on a ?No Find No Fee? basis; to find them you?re going to have to call around. A reputable real estate lawyer or securities lawyer should be able to refer you to someone.We are not stereotyping these middlemen. We?re merely suggesting that if you are dealing with an individual or a company whom you don?t know, you must check references.

You may even wish to perform a litigation search to see if the middleman has ever been a defendant in a lawsuit. This basic search should cost you no more than $100.Scams To Watch For (If you are an investor) Needless to say, the investigative and due diligence efforts that have to be made by an investor cannot be summarized in a few paragraphs.

There is an endless number of situations in which investors have been scammed lending money to new ventures that were nothing more than fraudulent paper corporations with no real foundation. The money gets invested into a corporation, the directors abscond with the money, and the company goes bankrupt.

The same scam can apply to fraudulent real estate deals.We would suggest that all investors conduct extensive due diligence and investigative research before extending money to any individual or company. It is important to investigate not only the company you?re looking to invest in, but most of all the individuals who are truly behind the company.

Do these individuals have criminal records? Have they been defendants in lawsuits? Is there a history of bankruptcy, in which the individual formed a company that was shortly bankrupted after being financed by investors?It will be necessary to know where these individuals were before they started their new venture. If they were in a previous business, why did it fail? What is the likelihood of success this time around?

We would again suggest that if you do not know how to do your own due diligence or homework (or you just don?t have the time) then you may wish to consider an outside source.It is best to go to a corporate lawyer (in the city where you reside) who can refer you to a reputable Private Investigator or Forensic Accountant.