A simple but highly effective due diligence check for emerging market companies is to verify if their auditor has changed in the past 10 years. An auditor change often signals that something was amiss with the previous accounting, providing a crucial warning sign for investors to investigate further.
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A key warning sign was when the founder's business partner stopped communicating with him directly and began consulting his accountant instead. This communication shift signaled a change in priorities from collaborative building to self-interested financial maneuvering before the exit.
A key due diligence red flag is management's history. Several board members were involved with companies that went bankrupt, and the CEO was previously the CFO at SunEdison before its high-leverage collapse, raising governance concerns for potential investors.
An expert reveals two shocking statistics: 80% of new founders fail their first diligence attempt, and 85% of early-stage investors don't perform confirmatory diligence. This highlights a massive, systemic weakness and inefficiency in the startup ecosystem, creating significant risk on both sides of the table.
Companies like Tether use "attestations" instead of full audits. An attestation is just a point-in-time snapshot of assets, unlike a comprehensive audit that reviews processes over time. Per Occam's razor, the logical reason for a firm to avoid a proper audit is the high probability of failing it.
Many PE firms use backward-looking commercial due diligence, which is superficial and fails to assess a target's true growth potential. A more effective approach is go-to-market focused due diligence that evaluates the scalability of the future revenue engine, not just past performance.
Instead of an immediate post-close review, conduct retrospectives 6-12 months later. The true quality of due diligence and strategic fit can only be assessed after operating the business for a period. This delay provides deeper insights into what was missed or correctly identified, leading to more meaningful process improvements.
When sourcing a carve-out proactively, the seller may not be fully committed. State Street recommends the seller commission a sell-side Quality of Earnings (QofE) report. Their willingness to invest in this serves as a strong signal of their seriousness and provides a more accurate financial baseline, reducing the risk of surprises during diligence.
Unlike in mature markets where non-compliance is a deal-breaker, it is common in emerging market family businesses. The investor's role during due diligence shifts from pure vetting to actively guiding the company toward compliance, making the process the first step in building a trusting partnership.
Before analyzing a balance sheet or income statement, read the footnotes. They act as a legend, revealing the specific accounting choices, definitions, and modifications management has made. This context is essential to accurately interpret the numbers and understand the underlying business reality.
A simple framework for assessing financial products involves checking for three warning signs. If it's too complex to explain to a 12-year-old, seems too good to be true, or lacks proper auditing, it's a major red flag. This heuristic helps investors cut through hype and avoid potential blow-ups like MicroStrategy's.