What is Individual Due Diligence (DD)? Part 2
Establishing A Research Procedure
In establishing a standard for DD procedures, individuals must develop the procedures to adhere and have wide suitability to business in general. Of course, any investor’s procedures will not be a cut and dried system guaranteed to work every time it is used. But there are certain basic steps involved in setting up a basic DD procedure that any investor can follow with some degree of confidence that they are at least getting more structured information that just random reading and comprehension.
First, always make sure the DD procedure addresses a specific area of information. That is unless the security being investigated is clearly a bad investment based on the 4 basic phases of initial DD. This may sound like an unnecessary caution, but it often ends up at the end of the day that you wasted a ton of time, effort and energy. However, once the DD has begun a set precise procedures can then be used for current and future evaluation. Sometimes a set of facts that represents a specific problem to one person does not appear to be a problem to another person.
For example, the company may be having production difficulties. To some this is acceptable and expected with a development company. Whereas, in the DD focus should address the why, so a determination based on facts can be part of the evaluation process as to its acceptability and expectation. Simply could the problem be the “Burn Rate” or capitalization the production?
Each DD phase should have a deliberate focus by which it can determine whether or not the data is available. Sometimes certain data is not available due to various reasons such as: it has not been disclosed (Financing terms, confidential financial data and internal operations, etc.). Even in a "Best Effort" some information is just not going to be available regarding a certain phase. However, the first task in doing DD is to gather together all the available information and arrange it in meaningful order to obtain a complete understanding of the company. Only then can a proper individual opinion be formed with an underlying basis. If no available information is available that becomes a gray area of speculation.
Establish the Facts
Each phase of the DD will have certain verifiable facts. These facts will be the underlying basis for phases of the DD that do not have verifiable information in order to form a investment potential.
Establishing the Investment Potential
Using this factual information, the individual investor can now have a basis for an "Educated Guess" for the investment potential. Thus in developing a investment potential, realistic tentative landmarks for the future must be established also that can be tracked to support the investment potential opinion. Things can change abruptly especially in the OTC market like massive stock dilution, numerous S8 filings, litigation, Burn Rate increase, lacking of infrastructure, synergy, etc.
Proving the Investment Potential
Each investment potential assumption should have both the positives and the negatives so a fair assumption can be tracked. Also the investment potential should show clearly specific problems at hand. The investor must examine the validity of each specific positive and negative in turn. It may be neccessary to share the investment potential with others for discussion as to whether the theory is correct or not. As each landmark gets verified, it becomes a fact for the most part. For practical purposes, this does not end the tracking process of DD, even though it is normal for the fact to be applied to the investment potential underlying basis. However, a fact can change suddenly.
Problems of Accumulating DD
Not being an insider is a specific problem in the data collection process. This should be taken into account as a significant consideration of any investor’s DD. The data verification used in research may come from either a primary source such as a SEC filing, transfer agent, etc. or a secondary source such as calling company alliances, neighbors, etc. However, always keep in mine that misleading and false statements can be in both the primary and secondary source. Also secondary data can be information that has already been gathered and published about the industry such as industry analysts, other governmental agencies, or other institutions like trade associations, or universities. Secondary sources are usually cheaper and easier to access than primary sources.
Primary information on the other hand is costly and takes time to gather. In doing one’s DD do not put the cart before the horse. Gather the primary data first and avoid secondary data sources until the primary has been fully established. The collection of primary data in researching a business presents a number of special problems for the investor. Particularly in terms of the money and time consumed in the fairy elaborate procedures of primary research. In most cases, at least four basic steps are involved gathering primary information:
1. Location of the primary source of information – Reading the SEC filings, news releases as far back as possible, transfer agent numbers, public corporate records, background checks, etc.
2. Designing a method of collecting data – Lots of reading and more information may be gathered by interviewing management by written questionnaire or phone conversation to get answers to particular focused questions and information.
3. Conducting field investigations - In almost every case, in order to have a proper well-rounded Due Diligence a certain amount of fieldwork is needed in the primary due diligence process. This gives a good idea of the company’s size and a solid feeling of legitimate business operations. Prior to visiting the company headquarters and/or satellite facilities have a carefully prepared questionnaire and plan of what exact events you wish to accomplish. Have questions that are redundant (just written in a differnt tone) and talk to as many company officials as possible to compare notes. Remember being liked is nonsense, the purpose is not a popularity effort but an information quest.
4. Personal analysis and interpretation of data - Once the raw information has been collected, it must be put into some type of outline in order to do a proper personal analysis. Not to write an analysis report but a specific organized agenda so the facts are not clouded by speculation rhetoric. This allows for specific tracking of the information to assist in making a logical reason for investing hard-earned money.
Once all information has been collected and organized, it may be necessary to calculate trends, percentages, or other figures on the basis of the raw data. All this activity takes time, special skills so do hesitate to call a professional such as an accountant or licensed financial advisor.
Operations Due Diligence
Operations DD is nothing more than an organized attempt to examine every possible factor that can affect a particular operation of the investment potential. Such as management’s ability to make solid business decisions and actually substantiate management is in fact pursuing a business plan. This includes close examination of the "Burn Rate." The amount of money that is exiting the company versus the amount of revenues coming entering. Particularly salaries, R&D, litigation, Overall G&A expenses, financing terms, debentures, and especially public relations and consultant expenses are just a few.
SUMMARY
Investor Due Diligence should always be a fair and open-minded organized quest for knowledge about an investment. True Due Diligence will be obvious facts that are verified information and very little assumption. In order to have a solid Due Diligence to base an investment decision on, the DD should be effectively broken down into phases such as management, stock structure, finance, products, industry, infrastructure, etc.
The Due Diligence should be performed so the investor’s DD demonstrates objectivity, accuracy, measurement, and verification. It consists of data isolation to discover definite problems and proceeds through the gathering of data to allow the formation of the investment potential.
If you can’t answer a legitimate question, if to no one but yourself, then why do you own the security?
To be continued …
Hey this is my opinion and I could be wrong!
Gary Swancey
