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Buyer Beware! How To Do Due Diligence On A Business

from Mark Mandula, Chief Marketing Officer

     


In the fast-paced and interconnected world of commerce and technology, the need for businesses to protect themselves has never been greater. Businesses seeking a provider for services must start a due diligence effort before signing any contractual agreements. If not, they put their own capital or employees at risk. Merriam-Webster defines the term due diligence as research and analysis of a company or organization done in preparation for a business transaction.

The failure to do due diligence can cause financial nightmares that may cripple a small business. I recently posted about a perfect example of this, it was the recent failure of a New York-based payroll company.

If you missed the story, the events and subsequent news ought to make any small business who subcontracts their payroll take notice. It reinforces the need for every business to heed the Latin warning, Caveat Emptor or let the buyer beware.

Quickly, a recap of the facts:

  • Over the 2019 Labor Day weekend, the worst nightmare became true for the employees of the 4,000+ clients of MyPayrollHR. The Albany-based payroll firm closed without notice and its parent company ValueWise disappeared.
  • Employees were left with no funds and many incurred significant late banking fees, overdraft charges and other fees that they couldn’t pay. Add to this the bounced check fees on checks already mailed and automatic payments to credit card companies, loans, etc. and you can see how many of these employees are clearly in a financial maelstrom.
  • According to published reports, the CEO of MyPayrollHR manipulated account numbers and moved workers’ money to a personal account.
  • And more recently, the CEO of the company, Michael Mann was arrested and charged with $70 million of bank fraud.

In the meantime, employees continue to rack up overdraft, late fees and potential scars on their personal credit scores because of the financial collapse of MyPayrollHR. Many of the employers could have taken out short-term loans or pulled money from their personal accounts and potentially damaged their credit scores.

For many workers in the United States, a missed paycheck is a disaster. According to a recent study conducted by the Board of Governors of the Federal Reserve System - 2 in 5 adults, if faced with an unexpected expense of $400, would either not be able to cover it or would cover it by selling something or borrowing. This documents what a financial and personal calamity events like MyPayrollHR can be for many workers in the United States today.

What can a company do to protect themselves from becoming a financial victim? My suggestion is to never enter a business agreement without using the due diligence steps that we will cover below. I should note, these steps will not prevent events like MyPayrollHR from occurring, but it will significantly reduce the risk of a financial disaster.

How do I do due diligence on a potential partnership? At our firm, we try to make this effort as easy as possible for them by providing references from our clients, CPAs, and bank and legal contacts.

Here are also some standard steps on how to start and complete due diligence on a firm you are thinking about utilizing for an outsourced service like payroll

Step 1: Understand your concerns

The world is getting smaller. The first step in a due diligence process should be to understanding what your concerns are and to make sure the firm in question meets your standard of integrity, performance and reputation.

Step 2: Define your objective(s) for due diligence

The due diligence you do must align with the risks your business faces. If you do business in countries outside the United States, take into account doing business with third parties in a region that attracts high levels of regulatory scrutiny.

Step 3: Develop a list of information to review  

There are a nearly unlimited number of templates online on what to ask for when putting together information on a relationship. As important as the actual data is, I believe the attitude of your potential supplier can say a lot. Do they offer a comprehensive and accurate package of data on their firm you before you ask for it? Do they want you to check them out and actually research them? Are they evasive and unwilling or do you have to make requests for basic information?

For a corporate entity, you should collect basic information including incorporation documents, details on key shareholders and beneficiaries, financial statements and references. If the company is publically traded, this effort is simple. In addition, rating services like S&P, Moody’s etc. are an excellent way to assess its overall position. 

Step 4: Conduct an objective risk assessment

Once you collect and review preliminary information, perform a risk assessment. This risk assessment is similar to the procedure of buying a business yourself. Lists should be comprehensive and include details about corporate structure and published financial statements.

Step 5: Carefully validate the information collected

After completing a risk assessment, move on to verify the information provided to you. Make sure you do not skip this step. This includes verifying information against public records, reviewing specialized industry databases or reports, and checking against legal databases to detect the litigation history of the firm.

Step 6: Continue to audit your own initial due diligence

Contrary to what happens, your due diligence should not stop when you finally selected the vetted firm. Never let your guard down and continue to audit your initial due diligence efforts. Ask simple but very important questions like; have they performed as promised? Better? Worse? Have they charge me exactly what they promised?  More? Less? Is the reporting and communication that which was promised?  Have they made my life easier? Do they add value to my business?

You ought to maintain an organized record of relevant documents to make sure the decision you made was the right one, strategically and financially. 

Step 7: Have an ongoing plan to monitor performance

Once partnered with the firm, you must actively monitor your ongoing relationship to insure that you are on top of it. This approach helps identify potential problems before your business becomes at risk. Unfortunately, even if an ongoing monitoring plan was in place, it probably could not have detected the overnight disappearance of $70 million of payroll money in a case like MyPayrollHR.

Step 8: Review your needs and due diligence process on a regular basis 

Think about the due diligence process and determine if you still need the service you receive from your vetted firm. Ask simple questions like “do I still need to use this service?” Is there a better option? Is their service keeping up with the changes in my industry? Do they add value to my business?

In conclusion, the need for every business to complete a due diligence effort is more important than ever. Recent unfortunate events like the MyPayrollHR debacle should serve as a reminder to business owners to complete a due diligence plan or risk exposing their business to potential harm.

Caveat emptor!

Article Posted On: September 25, 2019

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