When HP acquired Autonomy for £25.50 ($42.11) per share in cash, valuing the company at approximately $11 billion, it was one of the transactions that made the news and stayed in the news for a long time.
It was validation for the Venture Capital industry and for Autonomy and its team.
Earlier investors and the founding team smiled at the bank. It was an exit that excited the startup industry until its imminent failure became public knowledge.
When it failed, it stayed in the news for a very long time because of the players and also because of the Big 4 consulting firm that conducted the due diligence on behalf of HP.
The news that a transaction worth billions fell apart because financial irregularities conducted by the company and its executives were not observed and called out during due diligence.
Africa recently had its own share of these financial horror movies. Dash, a fintech startup in Ghana, faced similar scrutiny.
The company, which had raised over $32.8 million in venture funding, abruptly shut down operations in 2023 after discrepancies emerged in their reported transaction volumes and user metrics.
Investors discovered significant gaps between the company’s stated performance and actual operational data, leading to the closure of what was once considered a promising African fintech startup.
The loss of value at Dash could have been avoided if investors had paid attention to due diligence details; most of Dash’s investors and shareholders mentioned things were off and there were gaps they missed. Dash would later shut down.
Another news story about startup fraud in the technology and venture capital industry that rocked the venture industry is the acquisition story of Javice by JP Morgan.
A twenty-six-year-old female founder sold her business to JP Morgan on the back of the 4 million customers she had acquired in her student lending business. JP Morgan was impressed by the number of customers she had sought to acquire her business.
Post-acquisition, it was discovered that the customers she was alleged to have were not real customers but false names. JP Morgan sued and sought to recover the money paid for the sale of Javice.
More recently, a founder who raised $10Million on false financials was caught when she fabricated revenue figures and customer contracts during a subsequent funding round.
Due diligence by potential new investors uncovered the fraudulent documentation, leading to immediate legal consequences and the company’s collapse.
One thread that ties all of these startups together is fraud and the potential lack of due diligence by the investors who invested in the companies.
Fraud has no skin colour
I have highlighted these different universal stories because fraud knows no skin colour and is not the exclusive behaviour of one race more than another.
Certain regions and continents have been designated as fraud capitals, and regions of the world, I beg to differ.
Africa has not seen a lot of startup fraud.
However, I must add that here the reason why this might be the case is a result of the paucity of data for many things in the region.
In some cases, shame also factors in, and many investors would rather not be seen to have a fraudulent company and so prefer to keep the news under wraps, protecting themselves and invariably, the founders who committed them.
In the US, the SEC has also been instrumental in bringing many of these issues to light and publicly announcing when fines or penalties are levied against businesses and individuals who break securities law.
A good example here is the US SEC’s case against Tingo Inc. and its founder, Dozie Mmobuosi for securities and financial fraud. Tingo largely operates in Nigeria but was not reviewed or evaluated for possible financial fraud.
Another perspective that is often the case here is when the fraud is committed by an employee and not the business owners. From our experience, this usually stems from a lack of internal control, processes and compliance measures.
Employees see the loopholes and gaps in the processes and take advantage of them to make extra cash for themselves. We have seen this happen many times and fortunately caught it before it became too severe for the business.
What did these Investors Miss?
One of the reasons investors ignore Due diligence or neglect to conduct detailed due diligence is the cost.
Sometimes, investors compare the size of the deal to the amount they are investing and decide it is not worth it. Sometimes, it is because investors invest based on trust and believe that the founders are not capable of committing fraud.
Other times, it is a result of the amount of time it would take to complete the Due diligence process and wanting to move fast on the transaction so as not to lose momentum or seem “founder-friendly.”
In many cases, the dangers and impact of not conducting due diligence far outweigh the benefits of conducting them.
When organizations like Diligence Africa conduct Due diligence, the benefits are not just for the investors but for the founders. For investors, it provides detailed insights into the internal processes and workings of the businesses, allowing them to evaluate and observe how decisions have been made by the company and its leaders, and the impact of those decisions.
It provides data-driven insights enabling them to make investment decisions that are best for their funds.
In addition, when investors spot the issues within these companies, they can provide these insights in our due diligence reports to the companies to support them in rethinking and evaluating their reporting, financials, internal controls and processes since it highlights the gaps within the companies.
These insights have proved to be critical for the next phase of growth for these companies.
One key thing investors miss in conducting due diligence is solely relying on the information that businesses provide. The art of conducting due diligence is comparing information provided by the business with third-party information that has no origin from the business. In doing this,
Investors are able to spot discrepancies, gaps, misstatements or issues that may prevent the business from growing to the scale they imagine and also prevent them from making money on their investments.
In some cases, the founders of their business make a request for due diligence because they seek to understand their business in detail. When a business grows beyond thirty (30) people, it is often difficult to manage teams and have a clear line of sight in their internal processes and businesses. These are the critical moments when due diligence or business audits should be requested by companies. From our experience, many CEOs have been surprised by what they discovered going on in their business units that they had no clue about. We recommend businesses undertake the risk management process at least annually or bi-annually.
One example that comes to mind here is the Nigerian fintech startup founders who got jailed for user transactions for lax internal controls.
Although the fraud was committed by their clients, they were imprisoned because they failed to take the necessary internal controls to cure these problems and did not spot these gaps before the regulatory authorities caught them.
A bi-annual business audit on all the business units of the company would have prevented this from happening and a lifetime mark of reputational damage on the founders’ names.
How can Investors and Businesses protect themselves? We cannot overstate the importance of investors conducting due diligence. The benefits always far outweigh the risks of not doing this at all.
Our advice is no matter how small your cheque or investment in a company is, it is okay to conduct due diligence.
It does not mean you don’t trust the founders, it means you like the business enough to discover the loopholes in it so you can advise the founders on how to improve their internal processes.
In addition, recommending at least an annual business audit is a good compliance practice for the company and the investors.
Every company with a sizable number of team members usually falls prey to lax internal controls where there are none.
Working with organizations that have local intelligence and knowledge to determine where potential gaps and loopholes are is critical.
Organizations like Diligence Africa have extensive experience in this area and have the right team to support your businesses and investments.
Africa is no riskier than other markets, but a perceived risk has been attached to the continent for decades.
It is in our best interests to ensure we derisk investments on the continent by ensuring transparency in our processes and business dealings, conducting due diligence, and attracting the right global investors who can build on the processes we have laid and create scalable, financially sound, and sustainable businesses.
Damilola Thompson is the CEO/Co-founder of Diligence Africa, a risk intelligence advisory firm that provides risk management, fraud investigation, and due diligence solutions to
investors, organizations, and foundations. Our risk management solutions include financial due diligence, technology due diligence, commercial due diligence, reputation due diligence, and legal due diligence. Diligence Africa supports businesses with business audits, fractional CFO services, and governance and compliance solutions. Headquartered in Delaware, USA, with operations in 18 African countries, The company supports some of the continent’s most prominent and active venture capital investors.