We all do due diligence. Some of us do it in mergers and acquisitions (M&A). Some of us do it when we’re getting ready to make a major purchase like a house or a car, or when we’re getting ready to sign a contract for major home repair. Due diligence is the research you do to make sure that what you buy is what you think you’re buying. It’s verifying that the “facts” are correct as represented by the seller.
When witnesses are sworn in before their testimony in a court of law, they swear to tell “the truth, the whole truth and nothing but the truth.” It’s the “whole truth” part that’s usually the problem. The whole truth means that they have revealed all aspects of the truth — they haven’t just answered a question in a truthful but deceitful way. This is also the primary area of concern in due diligence: someone may answer a question truthfully, yet they’ve held back the information that you really need to hear. President Bill Clinton’s famous statement, “I did not have sex with that woman,” is an example of the truth but not the whole truth. He interpreted the words the way he wanted to, and told the truth as he wanted you to see it. And in due diligence that’s exactly the same thing that sellers are likely to do.
From my own experience in M&A due diligence for over twenty acquisitions, here is my list of ways to spot lies and omissions:
13 Ways to Spot Lies and Omissions
- Less detail in one area
When information is provided to you, there’s a consistent amount of detail provided in most areas, but less detail is provided in a few areas. There’s usually a reason they don’t want to go into detail in those few areas, and it’s in your best interest to find out why.
- Too much detail in one area
This is the opposite of #1, but the intent is the same. When you’re getting too much information about one area, you tend to pay less attention to the areas where the real concern is. They may be using a red herring approach — distracting you from the real problem areas. Or they may be concealing the problem area by overwhelming you with other information in the same area so that finding the truth will be like looking for a needle in a haystack (worse, actually, since you don’t know that it’s a needle you’re looking for).
- They keep changing the subject
Whenever the discussion gets around to a certain area, somehow the subject gets changed and the area never gets covered.
- People in one area don’t ever seem to be available
Isn’t it interesting that the experts you really need in an area never seem to be available? There’s probably a reason.
- Discussion on one area keeps getting pushed to the end of the agenda
When the seller knows you have a time constraint (like a scheduled flight), they keep pushing the problem area to the end of the agenda, hoping that you won’t take the time to do a thorough job.
- Accomplishments and plans blur together
This is particularly common when you’re discussing the capabilities of a system or process. The seller talks about planned capabilities as if they’re available today. This overstates the capabilities and gives you the impression that you’re getting more than you really are.
- The verb tense keeps changing
This is usually a tipoff that the seller is doing #6. Sometimes the seller says “the system will do something” and sometimes the seller says “the system does do something.” Or perhaps different people talk about the same capability: some using current or past tense, and some using future tense. Make sure you know exactly what capabilities exist today.
- Conflicting answers from different people
If different people give different answers to the same question, then the answers are suspect. Some sellers avoid this problem by making sure that all of your contacts stay in the room for all of the questions. That’s why it’s better to break up your due diligence into smaller groups for some of the detailed questioning.
- Physical cues: speech, tone, body language
Listen to the seller’s answers, but also notice how the seller is answering. In particular, look for differences in physical cues when certain subjects are being discussed. Sellers often exhibit stress when they’re talking about a subject where they know there are some concerns. The stress is visible when they act differently during discussions on those subjects.
- Web site and advertising don’t match what they’re telling you
If the seller is telling customers one thing and potential acquirers something else, then there’s probably a problem.
- Denial without explanation
The seller denies certain things, but makes no attempt to explain, probably because there isn’t a good explanation. Don’t take “no” at face value — ask why, and ask for examples to clarify the issue.
- Everything is perfect
I don’t mean to be cynical here, but the reality is that all acquisitions and purchases involve trade-offs. If your due diligence shows that everything is exactly as you would like it to be, then look closer, because something is wrong. I’ve never been involved in due diligence where everything was perfect; in all cases we had to decide whether the weaknesses we saw were outweighed by the strengths.
- Lost in translation
When doing due diligence in a non-English-speaking country, the discussions usually have to be done through a translator. It’s best (although more expensive) to use your own translator in addition to the one provided by the seller. If your translator is part of the due diligence team and committed to your success, then your translator should be able to listen for differences between what the seller says and what their translator tells you. Your translator should also be able to pick up on foreign-language discussion among the selling team participants. Often this discussion can reveal seller weaknesses or issues that the seller is hiding.
Sidebar: 7 Types of M&A Seller Behavior that Don’t Point to Lies
If you’re new to M&A due diligence, then some of the things on this next list may look suspicious. They’re normal, and perfectly acceptable in most cases.
- The seller wants to meet offsite, away from the office
This is normal. They probably don’t want employees to know, and they don’t want to start rumors. This is particularly true for M&A of public companies, where insider trading rules are extremely strict.
- Seller wants a confidentiality agreement signed before any discussion
This makes sense, and it goes both ways. If the deal falls through, then neither the seller nor the buyer want a lot of press, and they don’t want their secrets used against them.
- Seller wants you to destroy your notes if the deal falls through
This is reasonable, especially if the buyer and seller are competitors, since trade secrets may be revealed. It’s extremely important if the buyer or the seller is a public company.
- The seller hesitates in including certain people in the discussion
Most sellers want to keep the possible M&A deal on a need-to-know basis. The more people they include, the more likely it is that news of the deal will leak out. Note, however, that this conflicts with #4 in the first list. If you really need to know about a certain area, then you should insist on getting the answers you need.
- The seller doesn’t want its people to be seen in public with you
Again, this is to keep the potential deal a secret.
- Code names for the buyer and seller are used
This is common. On the M&A deals I was involved in, we made it a habit to never refer to the seller except by code name — even in private conversations or emails among ourselves. You never know who might be listening in. And make sure that the code names can’t be used to figure out the real name of the company (e.g., Redmond for Microsoft). Pick a name that has nothing to do with the company, their location or the business they’re in. Hint: Some companies who do a lot of M&A make up a long list of code names in advance, then for each transaction they just use the next code name on the list.
- If a site visit is needed, then the seller wants to use a cover story
Again, this is common. You might be introduced to employees as potential customers doing some background work before making a major purchase. Technically, you’re lying to the employees, but it’s closer to acting — you’re playing the role of a customer to get the answers you need to be a different sort of customer.