Reputational due diligence – background investigations on potential investments, including management teams and boards of directors – have proven their weight in gold time and time again. These investigations have stopped or repriced transactions, removed unsuitable management team members from deals, and provided investors with a level of confidence that glaring issues in management’s backgrounds had been identified.

While critical to the deal cycle, traditional corporate background investigations are “a look in the rearview mirror.” These efforts verify publicly accessible prior legal, financial, and reputational missteps, but offer little predictive value regarding an executive’s behavioral volatility, toxic leadership patterns, or hidden conflicts of interest or biases.

In an investment landscape defined by a rapidly changing market, extended investment holding periods, and intense regulatory scrutiny, human capital and corporate culture have shifted from soft human resource metrics encompassing employee satisfaction and talent management, to highly volatile financial risks, driven by toxic cultures, high employee turnover rates, and talent voids. To address these potential liabilities, there is a strategic necessity for advanced reputational due diligence that goes beyond public records investigations and analyses, which deploys alternative data sets to uncover systemic organizational issues or leadership misalignment that could be detrimental to a proposed investment thesis. Protecting enterprise value requires advanced diligence beyond customary public records examinations.

The Human Capital Blindspot: Where Customary Management Screening Falls Short

Traditional executive or reputational due diligence, usually the final hurdle in an investor’s due diligence, is comprised of a wide array of public records examinations in the geographies in which the executive has lived, worked, and is known to have traveled frequently. The output is an extensive dossier of the executive, identifying the information repositories examined and the relevant information identified.

Reputational due diligence is a necessary part of any contemplated transaction and provides a retrospective analysis of an individual’s publicly available transgressions. However, information about an executive’s non-public failings, or even more important, his or her day-to-day operational behavior, interpersonal skills or volatility, or questionable ethics – “the suitability” of the executive for the role and proposed transaction – are not part of the traditional analysis. The absence of such analyses presents a material risk to a deal’s success, especially if deep behavioral flaws, erratic management styles, or undisclosed personal conflicts surface only after the transaction closes and while the private equity investor is looking for immediate alignment between management and its operational partners. Misalignment at this juncture, in particular, within the first 100 days, creates operational friction that can stall execution, cause strategic paralysis, derail growth timelines, and potentially erode core underwriting hypothesis before value creation commences.

Assessing Corporate Culture and Leadership Alignment

Addressing the human capital blind spot requires going beyond management’s resumes and evaluating qualitative behavioral patterns. These qualitative people issues include understanding how an executive under stress treats subordinates or their decision-making framework during a crisis, or what his or her off-platform digital footprint may reveal about their ethics. A history or pattern of burning bridges or leaving a wake of traumatized management teams in an executive’s background is a leading indicator of an eventual leadership vacuum.

Likewise, a toxic or dysfunctional culture has a notable cost on an organization which can manifest into high employee turnover rates, potential litigation liabilities, reduced productivity, and a damaged reputation making it difficult to attract top talent. Conversely, a healthy, transparent, high-functioning culture acts as an operational catalyst that accelerates growth.

Assessing an organization’s corporate culture and identifying potential deal-affecting cultural issues involves utilizing non-traditional data sets. For example, workplace communities like Glassdoor and Indeed, social media forums like Reddit, along with other more targeted industry forums, track long-term sentiment regarding company cultural health and leadership approval. Other relevant sources of information for analysis require company cooperation, such as synthesizing whistleblower logs to understand the volume of internal complaints raised by employees and the efficacy of the mechanisms used to resolve the complaints. Similarly, a dissection and evaluation of attrition rates can provide insight into potentially problematic pockets within departments where spikes in turnover may exist, which frequently indicates a challenging middle manager.

It should be noted that nearly every organization has disgruntled former employees with stories to tell. It is critical that the due diligence strategy can differentiate between isolated, subjective grievances and systemic cultural disorder. Systemic issues are cultural patterns that are tolerated, covered up, or even actively incentivized, such as widespread discrimination or favoritism, structural harassment, or a normalized culture of “regulatory corner cutting.”

Implementing Advanced Reputational Diligence for the Deal Team

The advanced reputational due diligence playbook must be a combination of the old with the new. That is, traditional executive due diligence should continue, and public records reports should remain a staple of deal intelligence. However, diligence efforts should be enhanced to assess both the culture within the target organization, as well as leadership’s alignment with the strategy of the private equity investor. The advanced reputational due diligence playbook requires two fundamental pieces.

The investigation should entail not only the standard background methodology, but should also involve the corporate cultural assessment discussed above, as well as interviews undertaken by corporate intelligence professionals, skilled in identifying and interviewing people likely to possess relevant information. Experienced investigators leverage vast human intelligence networks, and can conduct discreet, off-the-record interviews of current and former employees or colleagues, vendors, competitors, and industry followers to piece together fulsome behavioral dossiers of the executive leadership team. Going beyond the public record and an executive’s curated public persona to provide color and insight into his or her leadership style, capabilities, track record, and anticipated alignment.

Next, the deal team must be willing to go beyond its comfort zone and dig into non-traditional areas of inquiry during management presentations and other question and answer opportunities. Standard questioning by fund deal teams allows practiced executives to deliver pre-canned, prepared responses. Getting to the bottom of potential reputational risks embedded in cultural or leadership issues will require deal professionals to dig into behavioral, structural, and operational questions that prompt executives to discuss their leadership style, how they handle friction within the organization, manage compliance and other risks, and address power dynamics.

Questioning during management presentations should be geared to understanding the executives’ potential alignment with investors and potential behavioral risk and assessing the workplace culture and any pockets of possible toxicity in the organization. For example, to elicit an explanation about how an executive may respond to what could be a volatile situation, one may ask about “how the executive has handled structural disagreements with his or her board of directors or previous private equity investors in the past” and to provide “a description of the mechanism for resolving the disagreement.” Likewise, “asking a question about the firm’s voluntary turnover rate and the root cause of such turnover,” may provide insight into the degree of responsibility the executive is willing to shoulder. Conversely, blaming the employees or the market may demonstrate a lack of self-reflection and an unwillingness to accept flaws or worse, in his or her leadership capabilities. In any event, carefully crafted questions supplemented with findings from reputational due diligence can provide invaluable behavioral and cultural information needed to assess an investment.

Conclusion: Derisking the Human Assets of a Transaction

In recent years, the importance of tangible assets in a transaction has shifted, falling behind intellectual capital, human assets, and brand equity, thereby placing enormous importance on the sufficiency of reputational due diligence and solidifying an understanding of the target’s culture before the close of the transaction. Continuing to treat reputational due diligence as the final, check-the-box exercise in the evaluation of an acquisition target, while also failing to assess an organization’s human capital sufficiently is perilous and likely to leave a private equity firm holding a potentially toxic asset. Conversely, integrating advanced behavioral and cultural vetting into the reputational due diligence process will increase the likelihood of a successful deal, facilitate post-acquisition execution, and lay the foundation for a track record that high-functioning limited partners and investors will flock to fund.

If you have any questions or would like to discuss how StoneTurn can help, reach out to David Holley.

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Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of StoneTurn Group, LLP, Province, LLC, or their affiliates. This article is provided for informational purposes only and does not constitute legal, financial, or other professional advice.