Yesterday I was reading an insightful article by John Mauldin, a renowned economist and whose views I religiously follow. John, in his article, introduced an interesting concept - The Lion in the Grass. Let me quote an excerpt from an essay by Frédéric Bastiat that John quoted in his article
"In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them"
In a recent speech that John gave in Singapore, he explored this concept in detail. His speech was based on a simple premise is that it is not the lions we can see that are the problem; but rather, in trying to avoid them, it is often the lions hidden in the grass that we stumble upon that become the unwelcome surprise. John explored this concept from an economic standpoint, wherein he analyzed the state of the world as it is today and introduced where he felt the global economy was heading
As a forensic consultant who has worked with a series of high profile investment banks & Private Equity funds, I find the concept rather intriguing. When an investor sizes up an investment, a number of consultants are deployed; These may include legal, financial, human resource, commercial due diligence, taxation and forensic experts.
In my experience, the first few consultants - legal, financial, human resource, commercial and taxation consultants - usually deal with "Lions" they can see. They rely heavily on data obtained from the following sources while consulting their clients:
- Interviews with the top management
- Provided by Investee company
- Public Domain & Subscribed databases
Not too long ago, most deal breakers not only relied heavily on such consultants for screening an investment but also believed that these consultants were sufficient as part of the deal screening process. The problem with this approach was that usually the data collated from above sources was accepted at face value and it only took a wave of corporate frauds and unethical business conduct by top management to change this perception.
Now, a forensic consultant is always thrown in the mix. Forensic consultants, like experienced hunters, often look for those Lions in the grass. I remember working on an investment wherein our client, a top PE firm, was exploring an investment in an emerging technology firm. The company claimed to have established a reasonable client base, the management team too was experienced, the employees were happy and there were no major pending litigation to speak of. Apparently, there were no Lions in the grass.
As we proceeded with our investigation, we realized that the one of the relatives of the promoter ran a similar business in the same building where the investee company's office was located. As we dug deeper, we realized that this other business was originally founded by the promoter and his immediate family and he had resigned from the post of the Director a few years ago only to be replaced by his relatives.
On our insistence, the client directed his financial due diligence team to check whether this other business had any dealings with the investee company. To his surprise, this other business was one of the largest vendors of the investee comapany. We proceeded and conducted some discreet interviews with some carefully selected stakeholders. Soon, it was clear that this other business was being used by the promoter to systematically siphon out investor's money. The lions in the grass were now visible and the client walked away from the deal.
I've realized that in today's fast-paced world, it is difficult to challenge the status-quo. There are deals to be made and bonuses need be cashed in. A thorough, detailed diligence usually requires a lot more effort, money and time. Moreover, there is the usual challenge of getting all teams - Forensic, Legal, HR and others to work together as one cohesive group. Sadly, it usually takes a few roaring lions in the grass for people to become more diligent and skeptical. Ethics, I believe, cannot always be taught. Sometimes, bad ethical environment is inherent part of certain organizations and cannot be fixed. However, we do have the option to choose the right partners and if we are diligent enough, we make the right choices.