The Art of Due Diligence - Part 1: The Path Through the Minefield

The art of good diligence is an essential part of any small company investor’s armoury. We might argue that is the most important if you allow the term to cover the breadth of checks that a professional investment manager will carry out. Gone are the days when due diligence covered basic checks on a company structure, its share classes, debts and management team. Investment managers are now looking at a more holistic approach.

Growthdeck: The Art of Due Diligence - Part 1: The Path Through the Minefield

So, for starters, we want to know what claims the team make when they pitch for money. Then compare these claims to the facts we can find out about the sector, its market and its prospects.

Not long ago, access to this sort of information would be for industry experts and those willing to pay them for it, like investment companies and PE firms.

The internet has changed all that. However, with easier and less costly or free access, comes some serious caveats. Fake news started on the web and, without it, it would not have had any chance of being credible. So it is with company, market and personal information. Sifting the wheat from the chaff is not easy but failure to do so will result in catastrophe. This is particularly pertinent if you are investing in equity crowdfunding.

Here we look at the records at Companies House and how best to use them, along with other online resources. In the next blog, we take a closer look at how to analyse the business, its scalability, its market sector, and external factors that might influence investments.

Companies House Records

Until recently, checks made at the Companies House website would only lead to frustration for the avid investor. You had to pay for any real information and it was delivered slowly by email – often only on the third attempt.

Now Companies House has a Beta site This gives you instant access to the latest filings, free of charge. It has been a game changer. So long as you know what to look for and are aware that, under the UK’s current accounting rules, most of the information filed is created by the companies themselves and is unaudited. There are numerous examples of false information in regard to annual accounts and annual returns being filed and accepted. The truth only comes out years later.

However, given you have to start somewhere, Companies House is the place.

It may sound obvious but the first step is to find the company’s registered name. This is often not its trading name. The easiest way to do this is to check their T&Cs on their website – this should contain the company’s registered name.

As a double check, the Companies House site will give you a list of directors – check that what you know fits with this.

Currently under UK legislation, companies with a turnover of less than £6.5m only have to file what are called small company accounts. This is essentially a one-page balance sheet. This does not give you a great deal of information. It is possible to ascertain from this page where the company was when it was filed, which will probably be at least 14 months ago. The accumulated profit and loss line gives an idea of its trading patterns. Although if the company is in profit, you have to allow for any dividends they may have issued. The debtors line will give a clue as to the level of turnover, depending on what type of business it is. Creditors and long term debts balanced against cash and debtors will show you the company’s liquidity.

Under the filings tab there is a list of the company’s history since incorporation, its M&A and other relevant filings. Worth checking any recent activity re share allotments, where you can find out what price these shares were sold at. It is also worth looking at the original directors and how many are still there – very few people resign from a company that is doing well.

The charges tab will give you the documents for any charges held over the company, which should relate to any long term debt on the balance sheet. It will also give a record of the outstanding charges and their due dates – you don’t want your investment to be used to pay an old debt.

If this all looks ok, cross checking the directors and their claims in the investment documents and their Linkedin page is a good idea. Many a time, you will find that the so called successful company sold on was in fact one that made no money and was actually bought out of administration.

Other tricks of the trade worth noting are multiple changes to the filing dates, late filings and corrections to filed accounts. All signal that the company is not being well run. One notice that appears frequently is the compulsory notice to strike off. This can be ignored if the reason is a late filing – too late and the company will be closed. Checking back through the filing history will give a clue as to what happened.

It is often useful to check the shareholders register – available with the annual return. You never know, you might find someone you know has already invested. It will also confirm any claims made that the company has VC backing and what size that backing is. There have been instances of claims made of key VC backers being on board. On checking the register, it’s clear their involvement is minor.

Checking company directors can be difficult. For some reason, the system we run in the UK allows individuals to have numerous persona at Companies House. The recent collapse of a company, which had raised money on a well-known equity crowdfunding platform, is a good case in point. The CEO had made various claims in the pitch about his previous and current successes. Checking his given name, showed nothing untoward. However, it came to light after the company had collapsed, that he was a twice bankrupt and had ditched several companies. Searches using his given name didn’t reveal any of this because he had 6 entries at Companies House, using different versions of his name, including one that misspelt it.  The only way to find if this is the case is to cross check.

A final caveat for Companies House information. As mentioned before, all the information at Companies House about small companies, is unaudited and was created by the company directors. Whilst it is an offence to file incorrect accounts, it happens often. HMRC simply do not have the manpower to check, so until such time as the rules change, you do have to view all this information with both eyes wide open.

Web Searches

The internet is both a blessing and curse for due diligence.

Using Linkedin, Facebook, Twitter accounts and the company’s own website, it is possible to find out about a company’s current activity and its history. However, all the information needs to be cross checked as it has generally been input by the company itself.

It’s worth using a site like Trustpilot to check customer reviews. Use Google Maps to check that company locations, especially retail sites, are still open. We recently found a large company claiming a unit in Cambridge, which had been the company’s flagship when they raised capital 12 months earlier, had closed and the lease was on the market – i.e. they hadn’t sold it. The unit still appeared on the web as live until you searched using Google maps.

Google also offers a free patent service which, when used in conjunction with the UK Patent Office, will give you enough information to check these.

There are various company checking websites which can prove a useful addition to Companies House data. Company Check and Duedil are two, although there is little point in paying for the information unless you don’t trust your own judgement.

Check the listings if the company is whole selling. A recent failed company was claiming listings in the UK’s leading supermarkets on its website. However, on checking with these outlets, they had been de-listed for some time – hence the company’s collapse. Again, the web tends to pick up information like this but it fails to correct or remove it when it goes past its sell by date. As anyone investing in or running start ups will have discovered, a new listing is only a listing when the customer pull through kicks in, otherwise it becomes a rapid delisting.

Dexster Growthdeck: Dexster


Who is Dexster?

Sometimes controversial, always trenchant, Dexster is Growthdeck's resident blogger. Dexster will bring you his/her views on the crowdfunding scene covering a wide range of topics, including the growth of the equity crowdfunding industry, the risks faced by platforms, how businesses are faring, what investors need to look for when choosing a provider and much more.

Note: The contents of this article are the author's opinion and have not been approved as a financial promotion.