Whether you’re considering a potential business partnership, exploring an investment opportunity, or hiring a new supplier, conducting thorough company checks to get a clear picture of a company’s history, financial health, and reputation is crucial. It’s vital to assess a company’s viability and mitigate any potential risks before getting into business with them, so that you can protect yourself and your company from any possible disasters further down the line.
In our last post, The Ultimate Guide to Company Checks: How to Do Your Due Diligence, we discussed how to conduct a comprehensive investigation and analysis of a company to assess its overall health, risks, and potential for success. And now, we’re looking at the key red flags you need to look out for to make sure you don’t miss any hidden problems that could affect you later down the line.
From financial inconsistencies to legal issues and weak company governance, there are all sorts of red flags that you need to be on the lookout for when you conduct company checks on a business that you’re considering engaging with on any level, whether that’s as an investor, partner or client. Here are the top five red flags that you need to watch out for when you’re doing your due diligence.
Know The Warning Signs: What is a red flag?
A “red flag” is a warning sign or indicator that alerts you to potential problems or risks. In various contexts, a red flag serves as a signal to exercise caution or investigate further. It implies that there may be underlying issues or concerns that warrant further attention, investigation or action.
In business, due diligence, and financial matters, red flags can indicate potential financial mismanagement, fraud, legal issues, or other problems that could affect the health or stability of a company. For example, inconsistencies in financial statements, unresolved legal disputes, or a lack of transparency in disclosures could all be considered red flags during an evaluation or assessment process. So it’s really important you conduct a thorough investigation into any company you’re thinking of partnering with, to make sure that you’re not running a risk to your business by going into partnership.
Red flags serve as early warning signs that prompt individuals or organisations to dig deeper, ask questions, and take appropriate steps to mitigate risks or address underlying issues before they escalate. It’s a preventative measure to ensure that you take care of any problems before you go into business with another company or individual.
5 Red Flags You Need To Look Out For
When conducting due diligence on a company, it’s really important to be aware of common red flags that may indicate potential issues or risks for your business. By recognising these warning signs, you can make sure you dig deeper to uncover any hidden problems before making any commitments or investments.
Here are five common red flags that you need to look out for, allowing you to approach due diligence with a critical eye and uncover any potential risks or issues that may not be immediately apparent.
1. Inconsistencies in financial statements
One of the first areas to scrutinise when you’re carrying out your due diligence on a company is their financial statements. You can use the Companies House ‘check company by registration number’ tool to get immediate access to a company’s accounts, including their annual returns – and it’s really important that you look through their statements from as long a period as possible (not just the last tax year!).
This allows you to gather enough data to be able to identify any inconsistencies, including but not limited to irregularities in revenue growth, overstated assets, or understated liabilities. These discrepancies are really important to look out for, because they could be indicators of financial mismanagement, fraud or inaccurate reporting. And these are definitely signs that this is not a company that you want to be working with! It could lead to you not getting the financial returns that you’d been expecting, and even legal issues if government requirements are not met.
2. Unresolved legal issues
Legal problems can have a huge impact on a company’s operations and reputation. Working through a court case or legal dispute can be costly and incredibly time-consuming, not to mention detrimental to a company’s reputation. So it’s crucial that you thoroughly review any pending or past lawsuits, regulatory violations, or other legal disputes. What are the nature of these cases? Where is the company at in the process of resolving them?
You need to think really carefully about the implications for your business if you get involved with a company that is embroiled in any kind of legal issue. As soon as you invest in a company, or make a company your partner, or employ a company as your supplier, you are linked to that company both financially, contractually and reputationally. So make sure you have all the information on any legal disputes before you tie your business to another company.
3. Lack of transparency
You can find a lot of information about a company’s financial history online at Companies House. However, alongside this publicly available information, it’s really important to ask the company you’re considering becoming involved with to disclose their balance sheets, income statements, and cash flow statements, and any other information that you might need to see to assess the company’s overall health, risks, and potential for success.
Be cautious if a company is unwilling to provide necessary information or if there are significant gaps in their disclosures. A lack of transparency could indicate hidden liabilities, undisclosed conflicts of interest, or other potential issues. And remember, whether you’re investing in a company or partnering with them or taking them on as suppliers, these are people that you’re going to be working closely with on a regular basis. So if the process of doing due diligence is hard, it’s likely that working with them will be even harder!
4. Poor corporate governance
Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It encompasses the relationships between a company’s management, its board of directors, its shareholders, and other stakeholders. The primary goal of corporate governance is to ensure that the company operates in a way that is transparent, accountable, and in the best interests of its stakeholders, including shareholders, employees, customers, suppliers, and the community.
The strength of a company’s corporate governance practices can be a good indicator of its overall health. After all, a business can only grow if it’s got a solid foundation in place! So when you’re doing your due diligence, take the time to review board structures, executive compensation practices, and make sure there are some independent directors involved with the company’s corporate governance. A lack of independence, excessive executive compensation, or weak governance structures can raise concerns about the company’s decision-making processes and accountability.
5. Negative reputation or public perception
Before entering into any business relationship, it’s important to consider a company’s reputation and how it is perceived by the public. Take a look at any online reviews, such as Google reviews, and any posts about the company on social media. How do the company’s customers speak about them? Are they positive? Negative? Is there room for improvement? Negative feedback or a tarnished reputation could be a warning sign of underlying problems, and could reflect badly on your company should you become associated.
It’s also worth considering whether the company engages in sustainable practices. With 61% of consumers saying a brand’s sustainability credentials are an important factor behind their spending decisions, it’s not likely to help your reputation if you go into partnership with a company that actively ignores its social and environmental impact. It’s important to ensure that the company aligns with your business values and your company mission.
Conclusion: Do your due diligence
When considering a partnership or any form of business engagement with a company, it’s crucial to conduct thorough company checks and due diligence to make sure that you have all the information you need to make informed decisions and protect your interests.
The five red flags highlighted in this article are key signs that you need to look out for in order to be alert to reasons that you might not want to tie your business to a certain company. Whether it’s inconsistencies in financial statements, unresolved legal issues, or a lack of transparency, all of these issues have the potential to cost you time, money and reputational merit later down the line.
In the ever-evolving landscape of business, proactive risk management is vital. By taking note of these red flags and leaping into appropriate action, you can mitigate potential risks and protect your company from unforeseen challenges. Remember, though, due diligence is not a one-time project. It’s really important to stay up-to-date on the companies you work with for long-term success and resilience in today’s competitive environment.
