The mistakes that can be made in business are infinite. They range from the simple -- "Hmmm, was I supposed to 'Buy low and sell high' or 'Buy high and sell low'?" -- to the more complex. Fortunately, most can be avoided through proper due diligence.
Here are horror stories that have transpired when proper due diligence wasn't conducted. If you've got one you want to add to our list, email Horror Stories.
Strategy Horror Stories
| Technical Horror Stories | Distribution and Logistics Horror Stories | Merger Integration Planning Horror Stories
| Finance and Accounting Horror Stories | Other Horror Stories
Strategy Horror Stories
Failure to Objectively Assess Strategic Criteria for Doing Transactions
A large transportation company acquired a smaller competitor to enhance its geographic reach. Cultural differences between the two employee groups obstructed necessary post-merger integration and ultimately the company went out of business. Root cause analysis indicated that the corporate development group had abandoned consideration of its strategic criteria for pursuing a deal, one of which was that target companies had to have a compatible firm culture. A quick third-party evaluation of the deal against the strategic criteria during due diligence would have avoided the problem.
Failure to Evaluate the Competitive Landscape #1
A corporate development executive at a biotechnology company read a flattering article about a new company. He went to learn more and became enamored with the company. Based on the rationale that he could sell the target company's products to his company's existing customer base, he pushed an acquisition through in record time but failed to conduct a detailed strategic survey of the competitive landscape. As it turned out, a competitor of the target company's, who was not quite as good at getting press but made better products, captured over 85% of the market. The corporate development executive moved on to become CEO of an internet company.
Failure to Evaluate the Competitive Landscape #2
A private equity firm invested in a specialty chemicals manufacturer on the basis of limited competitive market positioning with anticipated high unit pricing. Shortly after the acquisition closed, three competitors entered the market, driving prices down. The company had missed this possibility because it expedited the due diligence to get a deal done quickly; a strategic analysis of competitive threats would have identified the high likelihood of new competition entering the market.
Technical Horror Stories
Being Fooled by Demos and Vaporware
The tech industry has been built on vaporware and many are those who have been fooled by a good demo and a press release. One large software corporation acquired a small company that developed human resources software. The acquisition was largely based on a product demonstration that they believed was of a nearly finished product. The demo was only a prototype and by the time the product was completed, one year later, the market had passed it by. Ultimately, the acquired employees were laid off and the product was never brought to market.
Failure to Consider Underlying Component Technology Risks #1
Component technologies are occasionally overlooked. A venture capitalist invested in a software company that utilized a small company's technology for interlinking software applications hosted on disparate operating systems. Eventually, another large software company built this technology into its core system by acquiring a different small company and established it as the industry standard. This situation, one that the venture capitalists had never considered during their due diligence, set back the portfolio company's development plans by one year as they hustled to re-engineer their offering to use the new engine. They never caught up with their competitors who had had the foresight to support multiple engines from multiple vendors. Eventually, the portfolio company closed down and the investors lost their money.
Failure to Consider Underlying Component Technology Risks #2
A venture capitalist invested in a internet portal company that based its offering on an end-to-end internet service provider. The service provider supplied all of the back-end software that the company used at a phenomenally good price, allowing the portfolio company to get to market quickly at low cost and have a rock-solid technical infrastructure. Initial first round due diligence failed to identify the component technology risk -- what would happen if the service provider went out of business and stopped providing its content management software? Things went well for a long time, but, sure enough, the price was indeed too good to be true and the service provider closed down, bringing the portfolio company down with it.
Failure to Look at Target's Disaster and Recovery Procedures
An angel investor invested in a startup company providing niche editorial content to other companies via the internet. The angel did not engage a due diligence consultant to inspect the company and ultimately paid the price. After three months of content preparation, just prior to launch, a new employee at the startup accidentally deleted the content database. There was no backup. The company lost three precious months and its competitors passed it by, securing major contracts at key customers. Next time, the angel says he will engage a consultant to conduct thorough technical due diligence and make and follow-up on recommendations (e.g. implement reliable backup and recovery procedures).
Failure to Interview Target Company's Existing Customers
A design engineering software company managed to get acquired by a large engineering consulting company without ever putting the acquiring company in touch with any of its customers. As it turned out, the target company's customers were very unhappy with bugs in the core software product and the poor customer service they had received. By the time the acquisition was completed, most customers had switched to a competing product. The acquisition is considered by most insiders at the company to have been a big failure and a big mistake.
Failure to Appropriately Assess Intellectual Property
An investor group was approached by a company that was ostensibly a holder of a patent on a new technology that would greatly enhance semiconductor performance. A new company was formed to bring the technology to market. Initial discussions with prospective customers went well until it was revealed that the patent had been obtained in a foreign country, not in the United States. This avoidable due diligence oversight resulted in extensive litigation, failure to bring the technology to market, and lost investment monies.
Failure to Assess the Quality of Management Information Systems
A technical due diligence effort conducted by a junior venture capital analyst evaluated the target company's product technology appropriately but failed to examine its management information systems. These systems proved to be deficient and resulted in considerable problems and additional capital requirements. Proper technical due diligence could have avoided the problem.
Distribution and Logistics Horror Stories
Failure to Compare Project Sales Volume to Available Capacity
A manufacturing company projected growth in unit sales that far outstripped its plant's capacity for production. On the bright side, the target hit its projections but profitability was not reached because of the unexpected capital expenditures necessary to provide additional capacity.
Failure to Understand the Implications of Proposed Staff Reductions
An acquisition of a distribution company was predicated on costs cuts resulting from downsizing warehouse staffing levels. Ultimately, after the deal closed and the cuts were made, there were not enough staff in the warehouse to pick and fill orders in a timely fashion. It became apparent that the original staffing levels had been appropriate and no-cost savings were available. The company re-staffed and learned to live with lower margins.
Merger Integration Planning Horror Stories
Failure to Lock Up Key Executives
A large software company acquired a small network management software company, paying $8 million in cash and stock, most of which went to two co-founders. In a hunt for profitability, the acquiring company failed to pay attention to the two executives. Disgruntled and under-challenged, the founders left three months after the acquisition. Without their leadership, their employees also left and the product died a slow and painful death. Had proper post-acquisition planning been in place, the executives might not have been able to walk away so easily.
Finance and Accounting Horror Stories
Failure to Assess Proposed Product Prices in Pro Forma Financials
A venture capitalist invested in a third-party logistics firm that targeted e-commerce companies. Pro forma financials for revenues and operating margins looked great based on quoted prices but a short-circuited due diligence effort never realized that pricing was set at three times the current going rate. Revenues never materialized until prices were reset to market rates, at which point operating margins plummeted.
Other Horror Stories
Failure to Conduct Background Checks
An associate at a private equity firm was responsible for opening up operations in Eastern Europe. He discovered an opportunity to invest in a recently privatized manufacturing company. The CEO at the target company was charming and seemed competent. However, after six months of effort, the executive learned that the CEO had been convicted of embezzling money from a bank he worked at and had ties to syndicated crime. Having learned his lesson, the associate now makes sure that background checks are conducted first thing in the due diligence process.
Conducting Too Much Due Diligence
An acquiring company was so aggressive in its due diligence demands that other company was offended and walked away from the deal. A competitor ended up acquiring the company instead and conducted due diligence in a more structured fashion that prioritized the information requirements based on a high-level due diligence plan.
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