On 19 April 2023, K2 Integrity hosted a webinar highlighting the importance of conducting pre-investment due diligence for private funds. During the session, Skip Trachtman, client relationship executive at K2 Integrity, led a discussion with Mark Skertic, managing director, Investigations and Disputes, K2 Integrity; Alice Shone, senior director, Investigations and Disputes, K2 Integrity; and Ian Ivory, partner, Global M&A and Corporate, White & Case. To watch a recording of the full webinar, click here.

Recent high-profile banking and startup failures demonstrate the importance of pre-investment due diligence across the marketplace. Given the size and scope of many deals, and the resulting capital at stake, it is important for funds to leverage trained investigators who can provide actionable intelligence to help structure deals in a way that protects investors.

There are many issues that a trained investigator can uncover, such as undisclosed business interests, conflicts of interest, personal histories of potentially problematic behavior, gaps in a subject’s work history, political connections, controversial or unsavory business associates, hidden shareholdings/stakeholders, and/or material misstatements or omissions.

Below are four areas where performing—or not performing—thorough due diligence can have an impact:

1. Valuation: Without a full understanding of all aspects of the investment, a fund won’t be able to determine whether it is paying an appropriate amount.
2. Structure of the transaction: Information may come to light during due diligence that affects how the fund chooses to structure the transaction; it may structure the payment differently, put some money into escrow, or have a deferred incentive.
3. Personal liability: If the deal does not go as planned, both the fund as a whole and individual partners could be sued by shareholders or fund investors.
4. Reputation: There is the potential for reputational damage should the deal go wrong.

While there are multiple considerations in deciding when to engage investigators, as a general rule the earlier they are brought in, the better. The time to identify red flags is before the deal is finalized. It is also important to coordinate between the various parties to the due diligence process, such as legal, accounting, and advisory, to avoid competing requests for information.

When considering the level of due diligence that should be performed, it is important to remember that not all investigations are the same and not all deals require the same depth of investigation. Trained investigators can work with counsel and key members of the deal team to tailor the investigation to ensure it covers all relevant areas of potential concern and answers specific questions about the target company and/or management team.

The most basic pre-investment due diligence will verify publicly available information about a subject, search for issues of potential concern, and ensure specific industry sources are searched. A more in-depth investigation looks at more strategic issues and can do the following:

• Develop information regarding a subject’s performance and impact on businesses in previous positions
• Include discreet interviews with former supervisors and co-workers, former employees, industry peers, competitors, and others who can provide useful intelligence
• Provide insight into the target company’s internal culture and governance
• Develop strategic intelligence on issues like key person risk, government relations, and relationships with major suppliers, customers, and business partners
• Provide context for any and all findings to highlight their importance

When performing in-depth investigations, it is vital to work with a team with cross-border capabilities as most transactions span multiple jurisdictions. A cross-border team knows what is and isn’t available in the public record, and is able to identify gaps and conduct discreet source interviews in a culturally sensitive way that’s most likely to elicit the needed information.