Due diligence is conducted by a business seeking to purchase another business.
Essentially, it means that the buyer will check to ensure that the promises being made regarding the company it is buying are valid.
This is not to say that the company being bought is expected to be perfect – it may even be a distressed company that is up for purchase.
Due diligence is done to make sure that there are no surprises once the purchase is complete.
Investors conduct due diligence to various degrees at all times. You look into the stocks you’re buying, checking beyond just a dividend payment or price-to-earnings ratio.
Listed companies make this somewhat easier, as they have to follow the rules of being a company, as well as the JSE’s listing rules.
Further, with a listed company, there is often media exposure, while the asset management industry will also be scrutinising the shares.
That said, some problems still slip through (such as Steinhoff) and we end up with a dud.
But a recent flurry of emails I received alerted me to the possibility that investors are making transactions with large sums of money, often without solid due diligence. While much of this process is easy enough, investors are often blinded by the transaction itself, so they ignore any due diligence.
For example, when buying a car, you should not only be worried about price, mileage and model – you should also consider running costs and the cost of servicing the car.
When buying a house, it’s easy to fall in love with it and neglect to do all the digging you really should; maybe it is on a very noisy street or has structural problems...
A little bit of effort and maybe even some basic costing would have pointed out the potential pitfalls.
But what is really bothering me are the recent emails about “alternative investments” gone bad, or about “investment gurus” who turned out to simply be crooks.
Here investors are often blinded by either promises of excellent returns, or the novelty of the investment.
A regular question recently has been about investing in livestock via one of many different operations offering the option to buy a cow.
Aside from knowing little about rearing cows, most often no due diligence has been done on the operators.
With something like this you have massive counterparty risk, as there is no oversight body or regulatory exchange offering some protection if the operator goes bust or, even worse, just runs off with your money.
Generally, in this sort of situation your only recourse is via the courts – at best a slow and expensive process.
I also hear a number of horror stories about people having given money to a person who will manage it on their behalf promising excellent returns.
Usually these are on the more exotic side of investments, with one recently being on oil binary options out of the US.
In one case the investor lost all his money.
He knows exactly who is responsible.
But, again, the only recourse is via the courts and the expense makes it prohibitive. In this example, only after losing all his money did the investor embark on a Google search and discover that the Financial Sector Conduct Authority (FSCA) had warned about this individual – something he admitted would have seen him steer well clear if he’d done the Google search before handing over his money.
More recently, we saw a new local crypto coin being launched and it took me just five minutes of digging to determine it was not legitimate.
So, always remember the old adage: “If it sounds too good to be true, it probably is.”
Also: Never allow yourself to be blinded by possible returns. Always do your own due diligence – lots of it – and a Google search is often the easiest starting point.
Remember it is your money, and nobody cares about it as much as you do, so you have to do the work to protect it.