If you want evidence that looking beyond financial and legal due diligence can save you migraines -- not to mention large sums of money -- spend a little time with Alden Taylor and Pamela Volkman, founders of the global intelligence consulting firm Strategic Insights. With decades of experience in business intelligence, an industry that lies somewhere between strategic consulting and detective work, the two are brimming with tales of deal catastrophes they've helped clients avoid. Using a worldwide intelligence network, Taylor and Volkman work with Fortune 500 clients to uncover hidden threats that could be lurking inside a potential target company. Corporate Dealmaker's Suzanne Stevens recently spoke with them about what they call the "intangibles" that can unhinge a deal.
Corporate Dealmaker: Can you offer an example of an intangible that might be missed during due diligence?
Alden Taylor: In Latin American countries, a lot of companies will have financial consortia that will throw in a corporate dealer, an investment banker, an insurance company and a commercial bank, generally under a family ownership situation. We had a U.S. financial institution client that was looking at buying the insurance company in one of these consortia. The 80-year-old patriarch of the group agreed to sell our client a majority interest in the insurance enterprise. The presumption on the part of the U.S. buyer was that they would be partnering with the patriarch and that his heir apparent would be his son. We talked to people who knew the patriarch socially and learned that concurrently with selling the insurance operation, he was in negotiation with a European financial institution to sell everything else because he had no faith in his son or any of his other kids to run the businesses. This meant that our client would be a de facto partner with one of their large European competitors, and the law in this country is that partners have access to the financial records of the other side up to the parent company.
What happened?
Taylor: Our client walked away from the deal.
Pamela Volkman: We had another client who was getting into a deal -- an infrastructure project in the Middle East -- that involved a consortium of investors, and there were several people that looked wonderful on paper. But one individual who we were told would be supplying the know-how, it turns out his only experience had been as a heating and air-conditioning contractor. This was a billion-dollar fiber-optic project in the Middle East, and this was their point man.
Both those examples involved management and personnel issues. What other intangibles might fly under radar?
Taylor: Intellectual property is one. In some cases, what you find is that companies hold out that they are in essence operating on the cutting edge. They may be operating on the cutting edge, but the means by which they achieved this is something you don't want to be associated with. In other words, they have co-opted someone else's IP. Or they may say they're cutting edge, and you check and verify and find that they're just good at reading the technical literature and can make the appropriate oinks and grunts, and by the way they might be able to set up a prototype production line that would convince you that they're cutting edge.
Volkman: We did a case recently in the U.S. where there was this idea for a new type of laser, and it kept on being put forth at conferences. There was funding for it, and the company got great people on board. What we found was that after each funding, though, everybody got disillusioned, but the company kept getting funding through quite a few cycles. Our client was trying to decide whether to make or buy. After we finished, they realized there wasn't much to buy there.
Taylor: We sometimes call these the reverse United Way: The gift that keeps on taking.
Why do you think issues around management and IP get overlooked during traditional due diligence?
Taylor: In some cases, it has to do with the quality of information that people normally rely on to do this. If you're coming from a North American environment, there's so much secondary source information you can go to. Publications are very helpful in shedding light on potential players, and there's an awful lot of information gathered in the capital accumulation system and so many other things along that line you can go to. You get outside North America and Western Europe, and much of this information becomes less available, and what is available is highly suspect. The net result is if you retain the folks that you have traditionally used for due diligence here -- the lawyer, investment banker and accountant -- they will tend to look for the hallmarks of what they'd been used to using.
How do you go about uncovering these hidden or obscure variables?
Volkman: First we do the traditional by getting into anything that's available publicly. Then we've been very fortunate in our careers that we've developed a network of individuals that are placed in many of the industries that we do work in. These are people who have the contacts to be able to call up and say, "What do you hear about this infrastructure project?" These are people who not only have the knowledge in these particular areas but also the connections.
We prep them intensively. They know what we're looking for, though they don't know who our client is. We make up a tasking memo so they know exactly what we want them to do. This includes everything from talking to people, asking questions about companies and individuals, to actually getting into facilities when we need to know about process.
Taylor: Under ideal circumstances, regardless of country, we want someone who is an expert in the industry. We also want someone who is in the government as an elected official or in a regulatory position. We have one individual who has very good ties with various regulatory bodies in Brussels, and he's been very helpful. The most critical -- and this is where we play an elegant game of six degrees of separation -- is we try to get away from commercial relationship and into social circles of management. We might try to find someone who's gone to school with those individuals or who belongs to the same clubs. We want people who know those managers in an entirely different context, because the information might provide us with a slightly different view of their personality. It's then that you might find skeletons in the closet. In fact, we found out about the patriarch who was trying to sell his company in pieces through social contacts.
This all sounds so 007. How do you get the information you need while ensuring that people working for you don't cross any legal or ethical boundaries?
Taylor: That's a question often raised by our clients. Because we have long-standing relationships with resources, we are perfectly frank with them about what is acceptable and what's not. We set fairly distinct strictures that they can't cross. More importantly, we encourage them to tell us if they can't help us because they're covered by a nondisclosure agreement, it's too close to home or whatever. We also tell clients in exhaustive detail what we're going to do. We've often been retained by either outside counsel or general counsel, and we explain how we're securing information, and they can make a judgment.
The other thing is very important. When we do a study we rarely use only one set of resources, and that allows us to divide up the effort in a way where no one resource is fully aware of what we're pursuing. We tend to be able to fit the puzzle pieces together.
When it comes to technology or intellectual property, how do you get inside a factory without getting into an uncomfortable situation?
Taylor: Oftentimes what we find is that our people already have a reason to be in the factory or have been in the factory before. We've told clients right up front that our role is to determine if a wrong is committed. But if we have someone go in and they provide us with information, and in our judgment there has been no compromise of IP, our clients would get a one-line report saying your intellectual property has not been compromised.
Volkman: In other words, we will not go through the facility and lay out how the competitor is doing things. We have been fairly successful at getting into facilities, but not 100%. As Den said, the people we get in are generally people who have a reason for getting in either through a prior relationship or business, and luckily we've had a good record of that. But we don't hoist anyone over the wall.
Taylor: There are folks who work in this arena, and they're very good with 600-millimeter lenses and flyovers and all sorts of nifty things, but we haven't engaged in that. We've tried find someone who's been on a plant tour and will describe what they saw.
Are companies more sophisticated in knowing the right questions?
Volkman: Companies we've dealt with are definitely becoming more sophisticated. Part of the problem is that our industry is still pretty fragmented. You have this dichotomy. Some investigators tend to look backwards, and their work is often crisis driven. There's something that impels it. We look forward in our work. CD
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