True-Due Diligence: Or, Avoiding Failure When Due Diligence Says You’ll Succeed
by Mark Chussil
Investors suffer from a surplus of checks. I don’t mean checks in the sense of “here, let me write you a check.” I mean checks in the sense of due diligence, verification, and oversight. Not that there’s anything wrong with that, except for when they merely make sure you don’t overpay for your berth on the Titanic.
Some time ago I attended a meeting of investors, of whom I was not one. They filled a large, partially elegant room and listened to pitches from passionate entrepreneurs, of whom I was also not one.
The entrepreneurs all sounded highly competent, knowledgeable, and professional. They clearly knew their markets, their products, and their potential.
The investors all sounded highly competent, knowledgeable, and professional. They clearly knew investing, finance, and prudence.
I listened to the thirty or so questions asked by the investors following the entrepreneurs’ presentations. The questions dealt with checks for due diligence, verification, and oversight. Hey, if I’d been an investor, I’d want to be sure everything was legitimate too.
But that’s what every question was about. Every question sought a reason to believe that giving you a great deal of my money would be a wise move. Not a single question dealt with what could go wrong. What if, for example, a company already in a market wants to squash the entrepreneurial intruder? What if an applied-for patent is denied?
We humans are basically optimistic and energetic. We imagine things, we want things, we make things happen. I’m that way too; I wouldn’t have started businesses otherwise. But being an optimist doesn’t mean looking only for reasons to believe. An optimist steps up to a challenge. A fool steps off a cliff.
When we blend reasons to believe with ambition we get advocacy. I’m right, this is why I’m right, this is why we should do things my way, this is why you should follow me with your money or your career. That’s how we get ahead. That’s how we inspire action.
Due diligence may not protect you from frenzies of advocacy. At its worst, it’s like signing an ill-advised legal document because the spell-check said it was okay. Think it doesn’t happen? Remember that no one invests in a strategy or business expecting it to fail, yet somehow smart people invest in strategies and businesses that fail.
To make due diligence perform at its best, we must ensure that it does more than pummel the proffered reasons to believe things will go well. We must ensure that it also looks vigorously for reasons why things will fall apart. What if a whole bunch of mortgages sour at the same time? What if the market implodes for a couple of years? What if our product unexpectedly and publicly fails? What if credit dries up?
Looking at the dark side does not make you a pessimist or a naysayer. It makes you truly duly diligent.
There are many practical ways to do so. Stress tests. Business war games. Strategy simulations. What-if analysis. Thinking through a wide variety of scenarios. Role-playing with the equivalent of sparring partners. Corporate contrarians. Those are best practices used by optimists who want things to go right and know something can go wrong. After all, if an unexpected threat (or opportunity) can come out of left field, it is good to look toward left field before you commit to a strategy or investment. There are no guarantees, of course, but you can greatly improve your odds. I’ve seen it; it’s the rule, not the exception.
True-due diligence does more than protect you. It also helps you move forward, because you put together a better strategy and you have a better story to tell.
One last point. If true-due diligence demonstrates that it a strategy will produce unhappy results, that’s not a good enough reason to reject the strategy. First, you must compare the unhappy results to the outcomes you’d get under the status quo. If you get better results with the new strategy than you’d get without it, then, unhappy as it is, you should switch to it. Or, look for a better strategy. You’ve been forewarned.
“I observe the physician with the same diligence as the disease.”
John Donne (1572-1631)
This essay is a new, improved version of Checks and Balances, which this site retains for historical reasons.