Moral Due Diligence: What is in the privately held corporation’s closet?

Barry Gainsburg Interview With Ms. Vicki Hanson PhD Candidate in Public Policy & “Ganja” Reform Lobbyist
May 7, 2018
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Moral Due Diligence: What is in the privately held corporation’s closet?

Due diligence is an investigation of a business or person prior to signing a contract, or an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations. A common example of due diligence in various industries is the process through which a potential acquirer evaluates a target company or its assets for an acquisition.[1] The theory behind due diligence holds that performing this type of investigation contributes significantly to informed decision making by enhancing the amount and quality of information available to decision-makers and by ensuring that this information is systematically used to deliberate in a reflexive manner on the decision at hand and all its costs, benefits, and risks. –Wikipedia

As the age-old adage goes, an oral contract is only worth the paper it is written upon.  Even truer, is that a written contract is only as enforceable as the morality of the person executing it.

Generally, in business transactions, one is presented with a term sheet of the offering specifics, along with certain business, financial, and legal disclosures of past and existing conditions, along with contingent ones.  It is in these type circumstances that one is obliged to investigate the accuracy, completeness, and nature of the disclosures. This is fairly complex in public company situations. It is even more complex and delicate in privately held company situations since the corporate governance rules required by the SEC are not in force.

So where does one start the due diligence process in the private corporation transaction scenario?  Many times this involves a smaller pre-IPO company seeking capital from outsiders to allow it to expand and grow its business since friends and family have already been tapped out.  There is a desire to move the company forward to the “next level”. There are no SEC filings to review and generally there is a lack of audited financials.  Many of these upstart companies have been operating on shoestrings and suspenders.

First, it is essential that you really know the management of the private company you are considering partnering with.  The success of these companies in its early stages is based on personalities of the founders.  Although this does not provide financial or legal disclosure, it provides in essence what is “moral disclosure”.

Who is a management?  We are looking at the company’s CEO, COO, CFO and the rest of the “C” suite.  What is their employment history?  Have they been consistently employed?  Have they jumped from job to job, and if so what are the reasons?  What is their educational background?  Does their resume check out?  What is the word from the street?  What is the employee turnover rate?  Does management take a well- reasoned long-term approach or do they act capriciously and arbitrarily with their emotions controlling their decision process?  This is essentially a marriage.  You need to see your potential bride in the light of day warts and all so you can make an intelligent and well-informed decision to jump into the fray.

With dreams of public offerings, does management measure up?  Is there anybody considered a bad actor under the SEC rules, meaning they have certain felony convictions or other orders entered against them.  It would as a simple matter of course, make sense to inquire if anybody on a company’s management team has been subject to a conviction or other disqualifying event.  Most would be reluctant to disclose these type of events but it is essential to conducting due diligence to know who your “partner” really is?  One of the simplest ways to begin this investigation at no cost is to use federal websites such as the Federal Prison Inmate locator at and enter the name.  Should anything be displayed you can continue your investigation by utilizing a background report, as well as asking the individual directly.  You can also look at individual state prison inmate locator sites as well.

You may also wish to check court dockets to see if the company has been involved in litigation, but you may also wish to check into the litigation history if any, of the management team, individually.  This can tell you if management is litigious in nature or whether they have tried avoided legal conflicts. Does management fulfill its commitments?  If you are investing a substantial amount in a venture, the last thing you would want to see is the company using your investment which was intended for business growth to instead be used to fund litigation.  Especially, if it is unnecessary litigation.

Additionally, you will want to know the relationship amongst the management team.  Have they worked together successfully or unsuccessfully before?  Are they related by family?  Marriage? Is there an undisclosed romantic, current or former, relationship amongst shareholders?  What special issues will this create when you become part of the company?

Is there good morale at the company or does management create a situation where everyone is just interested in saving their own hides?  Is management respectful to its employees?  Do employees feel they are part of the team?  Does management view you as a true partner with a voice to be carefully listened to or are you just the most recent (and perhaps only) funding option?

These are tough questions that need to be asked and sometimes the results of this moral due diligence will be surprising.  So in concluding, traditional due diligence with regard to financial, business and legal issues is nothing other than mandatory.  However, enhanced due diligence of a company’s management team on the other hand while not mandatory, is certainly priceless.

Please feel free to reach out to me at [email protected] if you have legal issues involving the cannabis industry.  I am here to serve the cannabis community.

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