Are 3rd Party Due Diligence Services Really Necessary?
April 28, 2021
by a searcher from Northwestern University - Kellogg School of Management in Chicago, IL, USA
I've seen some wide ranges on what a searcher should expect to pay for due diligence on smaller deal sizes ($1M-$5M deal range). Looking for anecdotes where making an investment in 3rd party due diligence paid off for you. I'm of the opinion that, as a prospective buyers, you should be intimately aware of all financial/legal/technology details of the target company and by paying a 3rd party to do this tedious work you are 'cheating' yourself of that knowledge. What am I missing?
Keeping anonymous because I am not ready to broadcast my intent to search.
from University of Texas at Austin in Houston, TX, USA
I've found that new buyers hire due diligence companies (like ourselves) to really protect their overall investment. With these buyers, we're doing###-###-#### % of the total due diligence being conducted and they're relying almost solely on our findings to make a buying decision. Again, in these cases, our services become somewhat critical because we become the final source of truth for these buyers.
The interesting and somewhat surprising part is that we work with a lot of very established buyers, often in the form of experienced, portfolio buyers and long-standing funds. With these buyers, you have primarily two types:
(1) Those looking to conduct due diligence on components their team doesn't have expertise on e.g. highly technical due diligence such as a codebase/tech stack review conducted by a software engineer or a QoE report prepared by a CPA. This one makes sense as we help complement their in-house due diligence expertise and fill in any gaps of knowledge or expertise.
(2) The second one is those simply looking to verify their findings. Initially, this seemed strange to me, especially for funds that have been around for a long time and have really perfected their craft in the due diligence department. However, from a numbers perspective, it makes a lot of sense. Most of the time, these companies are spending a small fraction of a % on the total purchase price on outsourced due diligence with us, and most of the time, we find a lot of what they've already found. However, there have been quite a few instances where we've found something that really changes the course of the deal (for better or worse) and at that point, they're quite relieved they forked out that relatively small amount to a company that specializes in due diligence to help them save on the months and years of headaches that come with a bad acquisition.
So really, I'd say it depends on your own expertise and what the due diligence company brings to the table. For example, if you're buying a SaaS business and don't have technical experience, a company like ours can likely provide a lot of value as an experienced Software Engineer will do a technical deep dive into the codebase and technology stack. If you're buying a restaurant and want someone to conduct on-site due diligence, we can't provide a lot of value there. So I'd always recommend understanding where you need the most help and why the due diligence company you're hiring has the expertise and track record to fill in those knowledge gaps for you.
Happy to answer any follow-up questions or feel free to private message or email me at redacted And don't forget to check us out at rapiddiligence.com if there's an acquisition we can help you with!
from The University of Chicago in Chicago, IL, USA
1) Do not seek DD experts from one referral source.
2) The most important DD is the "business" DD; it is not legal, not accounting, not tax, not IT, etc. What is a "business " DD. I don't have a full definition but it should include, a) Why does the business have sales? and b) Why does the business make money on those sales?
3) You should be able to ask the DD person "is this right target?", "what are the risk?" etc. If you nickel and dime DD cost, you risk getting honest advise.
4) Lenders are often a good sounding board.
5) If one thinks that the B-school has taught everything about buying, owning and running a business, you are in for a big surprise once you take over the keys.
6) A business has to fit you, your personality and your life style.
a) A magazine is a new product every month and has critical deadlines every month. Do you have the personality for that?
b) A labor-intensive manufacturing company will have high labor turn over, Monday morning sickness, etc. Can you handle that?
c) A technology company will have highly-educated staff. Can you work that?
d) A company's customers require entertaining (golf, sports games etc.). Does that suit you?
e) etc.
I can go over 100 such questions that I have learned through the DD advisors of my clients over 35 years of M&A and teaching at Kellogg and other venues.