Intelligent Deal Making: Four Circles of Defense

One of my clients was recently considering a joint venture with a California-based firm for the purpose of entering the Chinese market, and requested that I conduct a simple examination of the prospective partner, its background and its operations. After spending approximately half a day on the project, I discovered that the firm was nothing but a corporate shell established to deceive its customers.

My client’s modest investment in a simple due diligence project saved it hundreds of thousands of dollars, not to mention precious months of potentially wasted efforts. This article offers an easy-to-follow, low-cost approach to smart deal making. The system, known as Concentric Defense, consists of four increasingly wider circles of information, each designed to expand your level of comfort with your potential partner. These circles are: online investigation, the business intelligence report, a company interview and external verification. Bear in mind that you proceed with the steps in the next “circle” only if the prospect clears the previous level of investigation.

CIRCLE ONE:
ONLINE INVESTIGATION
The Internet is probably the most powerful business intelligence tool ever invented. When investigating a potential partner or client, it is always a good idea to start with a simple Web search for the name of the company and the names of senior executives. Such quick searches, which we have conducted on behalf of clients, have turned up information about legal proceedings, criminal allegations, competitive information and more. This valuable information is freely available, yet most business executives never bother to search for it.

When visiting the company’s own website, ignore the branding and marketing hype and search for real information that you can use in your investigation. Make sure that you take a look at the Investor Relations page, usually found in publicly traded companies’ websites. This typically includes SEC filings (also available on the SEC’s website), annual reports to shareholders, proxy statements and more. You may also be able to obtain the names of current and former clients and former executives, all of whom you may choose to contact for information later on in the process. Be aware, however, that much of the information obtained from the Internet may be false, inaccurate or outdated. For this reason, due diligence efforts should never be confined to the Internet. The information obtained must be verified and cross-checked against real-world information sources. This is where the second circle of the Concentric Defense system comes into play: the business intelligence report.

CIRCLE TWO:
BUSINESS INTELLIGENCE REPORT
These days most of the basic information you need to know about a potential partner can be reliably obtained from a business intelligence report that you can buy online for a modest fee. These reports are available from such companies as Dun & Bradstreet (dnb.com) and other service providers, and typically cost around $100.
A typical report contains information about the company’s sales figures, number of employees, main place of business, liens and much more. The business intelligence report allows you to establish the accuracy of some of the basic information probably provided by your partner. It also allows you to immediately spot some of the major red flags of which you should be aware. These include problems with credit history as well as judgments, liens and suits against the company.
The information contained in these reports makes them an invaluable resource that should be part of any due diligence process. Nevertheless, such reports probably do not contain all the information that you need to evaluate your potential partner. Therefore, consider the third line of defense in the Concentric Defense system: a company interview.

CIRCLE THREE:
A COMPANY INTERVIEW
It is extremely simple to collect large amounts of written data about a possible partner, but such information can take your investigation only so far. If your company is about to enter into a major transaction, you need to corroborate the written data you collect, and the best way to do this is to conduct a face-to-face meeting. A short visit to a prospective partner’s facilities can teach you more about that company than days of scrutinizing SEC filings or analyzing websites. Holding face-to-face discussions will also allow you to evaluate the body language of partner executives and to gain a firsthand understanding of the relationships and power structure within that company. In cases where a visit to the partner’s facilities is impracticable — for example, due to time constraints or geographical distance — comprehensive phone discussions with multiple partner executives can provide many of the benefits that can be gained in a face to face meeting.
Here too, some caution is warranted. Fraudulent operations can go to great lengths to present a believable front, and have been known to manufacture entire operations to fool visiting executives. On the other hand, during a recent visit to the world headquarters of an established market leader in the security industry, I was surprised by the dilapidated facilities, and had I not known differently, I might have suspected that the company was experiencing financial difficulties. In short, it is wise to remember the old adage: Looks can be deceiving.
For important deals, the first three circles of defense may not be sufficient since they rely heavily on information volunteered by the partner. The fourth and final Circle of Defense in the Concentric Defense system overcomes this limitation by obtaining information from external parties.