Due Diligence in Asia – The importance of knowing who you’re working with.
It’s an accepted fact that there are tangible risks in business in Asia, whether you’re considering a merger or acquisition, investing in a company, forming a joint venture, establishing operations, buying real estate or procuring inventory or assets.
Speak to any veteran businessman with years of experience in the region and you’ll learn of an almost never-ending litany of horror stories. Among these conversations its common to hear of financial losses and delays, caused by partners who fail to perform; purchases of stock from businesses in Asia, for products that never arrive; falsification of documents and other fraudulent acts; and/or third party deals at inflated prices (that are always detrimental and usually unbeknownst to your business. Tales of stolen stock, stolen capital, and many others.
Ex-pats right across Asia will have seen the daily scams. Apartment and housing scams, food scams, counterfeited medicines, through to more sophisticated scams such as the recent case of Australian investors who lost $7 million in a property investment deal gone wrong deal in Vietnam, or the 250 people who lost approximately $35 million in the of Suisse International’s Gold Buyback Scheme in Singapore.
Business risk is a similar story. Risks are exponentially greater in Asia, where corruption, bribery and limited regulatory oversight is common.
Consider Caterpillar’s $886M acquisition of ERA Mining Machinery in China as a case in point. Caterpillar has been forced to subsequently write off $580m, almost two-thirds of their investment and half the company’s quarterly earnings, much to the outrage of their shareholders. Caterpillar’s CEO, Douglas Oberhelman stated that the company had “. . . uncovered deliberate, multiyear, coordinated accounting misconduct” after performing a physical inventory audit, some months after the acquisition. This led to a trail of very elaborate and sophisticated fake documents.
Regardless of whether the books and paperwork appear to be in order, a thorough examination of the operations and physical assets is critical in assisting to reveal the true financial health of a partner or acquisition target! Had Caterpillar performed their examination prior to the acquisition, $580m of losses, and countless damage to their brand and reputation could have been avoided.
Finding and Testing a Partner is Crucial but Difficult
Businesses operating in the region recently identified the selection of partners as one of the greatest and most difficult challenges they face. Whether your business is a large corporate like Caterpillar, or an SME doing business in Asia, regardless of your level of experience operating within the region, finding reliable and trustworthy partners remains a massive problem.
To invest successfully and operate in Asia, it’s of paramount importance to know exactly whom you are dealing with, their capabilities, their reputation and their track record.
The choice of the wrong partner can wreak havoc on operations, on your brand, your profitability and ultimately on the survival of your business. To make matters, worse, even where it’s clear that your partner has defaulted under your agreement, corruption, bribery, the lack of regulation, and a weak judicial system means that more often than not, you’ll simply be throwing good money after bad.
Almost a Third of Companies Neglect Due Diligence
Given that Asia is awash with tales of unscrupulous partners and of foreign investments gone awry, it is clear that due diligence is simply not performed often enough. Ernst & Young has reported that, despite the dangers, approximately 20 percent of companies fail to conduct any pre-acquisition due diligence, and a further 11% rarely do so!
Additionally, and just as surprising, the report also stated that a remarkable 42 percent conduct no due diligence post-acquisition either.
Whether it be due to positivity and optimism at the outset of a relationship, or due to a misguided opinion on the value of the exercise versus the cost, the reasons for the lack of due diligence are unclear.
Operations Yield the Strongest Clues
Given the potential for risk and loss, the lack of a thorough due diligence investigation into potential partners within Asia, is truly staggering. As Caterpillar, and many other companies have found, it’s not enough that partner agreements and contracts stack up or that everything looks good on paper!
A thorough investigation of a potential partner’s operations, facilities, company structure, trading history, employees, customer and supplier relationships will reveal far more about your partner and their abilities, than any amount of paperwork.
The process of integrity due diligence (IDD) is simple and yields highly valuable information. An effective IDD check can reveal a lack of transparency, poor reputation or track record, records of past or present corruption, questionable political support, links to organized crime or money laundering activities as well as uncertainty over key assets and licenses.
There is no substitute for working with trusted due diligence advisors who are on the ground in the region and who are skilled in both commercial and criminal investigations of potential partners within Asia.
At SMCS Risk, we urge all of our clients to look beyond the paperwork and beyond the facade of the business of any potential partner in Asia, prior to making any significant investment.