Personal War Story: When the Due Diligence Checklist Failed

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If you are looking for an acquisition due diligence checklist, you can simply type “Sample Acquisition Due Diligence Checklist” into your web browser and you will find plenty of options to choose from.

Chances are you will find a checklist that is adequately fit for purpose.  But take my advice as the voice of experience:  While it might be adequate, it will not be sufficient.  And it just might fail you.

In 1997 my partner and I learned that lesson the hard way after acquiring our first business.  Months of searching had finally led us to an acquisition target.  With a checklist in hand we entered the due diligence phase of the acquisition with enthusiasm and discipline.  We checked the boxes, closed the deal, and became proud new owners of a railroad car repair and body shop business.

Then one day we find out that our checklist did not have a box for the vital question: “Who owns the railroad track?” That oversight came back to bite us in the wallet. 

Our Story

The railroad car repair and body shop was uniquely located on a site where railroad cars could be re-directed and the work could be done.  The site itself was a vital strategic asset necessary for conducting business.

We purchased a business that was situated on a bankrupt railroad property with a rather opaque, cloudy history.  As part of the deal, in addition to buying the company assets (equipment, inventory, receivables, etc.), we assumed leases for the property and various buildings that comprised the site. 

Things were going quite well.  That is until the day a guy showed up on our doorstep claiming that the railroad track that was essential to operating our business was his personal property. He offered to sell it to us – and you guessed it, at a hefty price.

To say that we had a dilemma on our hands would understate the direness of the situation.  Without the track, we did not have a business.  Our lease on the property did not include right of use of the railroad track, or so he claimed.  Our investment would be worth nothing.  We’d be deeply in debt with no means to repay.  And the workers who trusted us with their livelihoods would lose their jobs.

As first-time business owners, we didn’t have the financial appetite to hire a legal team to challenge the legitimacy of his claim or take the battle to court.  And we didn’t have the means to ascertain the ‘fair market value’ of the railroad track or question the reasonableness of the six-figure price tag he had placed on the asset.

As young entrepreneurs, we had missed a major due diligence detail.  The legal firm we hired did too.  After all – “Who owns the railroad track?”  was not on our due diligence checklist.

In the end, we paid up and moved on to build the business into a thriving and profitable company.  But not without a few lessons learned.

Our Lessons Learned

What could we have done differently?  How could we have avoided missing something so essential to the viability of our business? 

Here are three lessons we learned that helped us avoid similar pitfalls as we acquired other businesses:

  1. Sometimes checking the box isn’t good enough.  Take pause and look beyond the obvious and assess the big picture. Apply common sense and challenge yourself about practical items like “Who owns the railroad track?” that won’t be a standard box on a due diligence checklist.
  2. Realize that the due diligence process is resource and budget constrained. Because you will not have unlimited time and money to spend on due diligence, you will need to prioritize. Considering that all checklist items don’t have the same strategic value, ask yourself what items are most valuable to the viability of your business and prioritize your activities and spend accordingly. For example, chances are you won’t have the time to interview all your potential customers.  But if 20% of them make up 80% of the revenue, hopefully you’ll prioritize your due diligence time to reach out and talk to them.
  3. Make sure your assumptions are correct.  Our biggest mistake was that we assumed that the railroad track would be included in the property leases. That’s because we lacked the experience to realize that even what seems like an obvious assumption requires proper validation.  And this was an incorrect and costly assumption.

One thing for sure – things would have worked out much differently if we had simply asked “Who owns the railroad track?”

If you this considering acquiring a business or need some advice as you enter into the due diligence process, I’d welcome the opportunity for an introductory video call to learn more about you and your goals. You can schedule a free 30-minute consultation here.

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