From the AEGIS e-Journal, Volume 1 Number 1, November 1998
This is story is of a recent due diligence investigation of a proposed acquisition. The client intended to acquire the company and hire its owner. The owner was an experienced inventor of automatic weapons technology, and the company was a manufacturer of automatic weapons components to be sold to other companies that would integrate these products into there own weapons. The key assets of the company were the 13 patents filed both domestically and internationally on the technology for weapon components. The second key asset of the company was the owner himself. The owner is important because, while patents describe the science behind a technology, they rarely describe the art of making the technology work. The due diligence process began with specially formatted questionnaires. The questionnaires used for this investigation were a corporate questionnaire and a key-individual questionnaire. Every officer, director, and key person in the company received a key-individual questionnaire. When the completed questionnaires were received back they were late, not prepared in accordance with their instructions and incomplete. This is a red flag. If someone selling a business for $750,000 and cannot take the time to complete a five page questionnaire accurately and completely, there is usually something wrong. Several claims were made by the selling individual. These claims related to the patents, capital equipment of the company, and the ability and skill of the individual. An investigation of the patents with the U.S. Patent and Trademark Office showed that the Patents were null, void, and now public domain: There is an annual maintenance fee required to keep the patents in force. The maintenance fee had not been paid for many years on any of the patents. An investigation of the principal showed that he was a convicted felon. He was convicted on a federal government contracting billing scheme where he over-billed on products and services. (It gets better) During the entire time he was operating the company he was trying to sell – he was on a prison work release program! This was a result of his government contract billing scheme conviction. He could work at the company during the day but had to go back to prison at night and on weekends. Also, as a convicted felon, he could not be anywhere near a firearm of any sort whatsoever let alone own a factory that produced components for firearms. (It gets even better) ÆGIS, November 1998 3 On investigating the company it was found that the owner did not own the company. It was set up in the name of relatives who were acting as his nominees. It seems the federal government wanted its money back, and he was under a requirement to pay restitution and damages of almost $400,000. This restitution this would put a substantial dent into the money coming from the sale of his company. To add insult to injury, it appears that he had sold or licensed the patents to several other companies. Two of these companies had recently filed civil racketeering suits against the individual and the listed owners of the company. When his relatives learned that they were being sued for civil racketeering because of their entrepreneurial relative, you could practically hear their screams from coast to coast even without a telephone. Suffice it to say the client passed on the company. The due diligence investigation occurred near the end of the transaction. The acquisition documents had been drawn up and the accountants had reviewed the books. The books were good. The company’s sales and client base were accurately stated. But it was a mess beyond belief. Approximately $15,000 had been spent on attorney and accounting fees. The due diligence investigation cost less than $2,000. Had the transaction been completed, the liability incurred by the accountants and the attorneys could have been substantial. The loss to the client could have been corporately fatal. For their own protection, the owner’s relatives notified all authorities and regulatory agencies of the real nature of his activities. As a result, three months after the client passed on the acquisition opportunity the Bureau of Alcohol Tobacco and Firearms closed down the plant and caused the owner’s parole to be revoked.