Michael discusses best practices to conduct due diligence in Merger and Acquisition (M&A) transactions in Greater China.
What You See is What You Get (WYSIWYG)
Due Diligence in the West:
- Takes place prior to a transaction with data rooms, disclosure schedules, interviews with CXO’s and professionals.
- Studies, reports, financial statements, taxes, depreciating, experts.
Due Diligence in China:
- Process of verifying and ascertaining the positive/negative aspects of a business.
- Similar in spirit in that the goal is to verify information to make a decision on a transaction but the similarity stops here.
- Does not focus solely on the target or the deal points between the two parties but also on issues of the larger society (e.g. business dealings and relationships with customers/suppliers and positioning of them in evolving society).
- Constant process.
- If a western CXO does not get information about the changing flow and motion and trends on key issues, rather than merely the snapshot at closing, the CXO may not have accurate information to assess the potential for the venture or to protect the investment.
There are lies. Worse than Lies, There are Damn Lies. Worse than Damn Lies, there are Statistics.
- Annual Provincial GDP growth rates reported levels above the national average in all provinces except one (Xinjiang).
- There are Two A’s in GAAP Accounting. This is not about checking the work papers. This is about checking the flow of funds and assets and liabilities.
Rashomon Lives: What Due Diligence is Not
- State-Owned Enterprises (troubled, reorganized, corporatized, monopolized), Township Village Enterprises (TVE’s) and Private Companies are in three different realities.
- Assumptions about power, water, logistics, distribution channels, social entitlements, labor productivity, hiring/firing, government relations, liabilities are different on paper and in reality.
- No central registry for data, no debt registry, no central police file or environmental file, no way to find liens or debts except manually.
- Different assumptions on the right or obligation of disclosure.
Rashomon Lives:
- Management and operational realities govern. China due diligence is NOT about “informational verification, production of documents and completing checklists”.
- Western Approach to Environmental Compliance: Review the permits, letters, awards, correspondence file and see the plaques vs. walk the entire plant tracing the waste disposal process and systems. If the shoes (don’t) dissolve, the due diligence report is complete.
Due Diligence in China is:
- The active process of gathering information,
- Verification of information (not documents)
- The interpretation of that information in the context of Chin now and what China will evolve into during the term of the venture.
What is Societal Context?
- What are the appropriate approvals at the local, provincial and national levels and in what order are they required?
- What are the relevant agencies at what levels (up/down) and inter-agency relationships between different bureaucracies (left/right)?
- Central level/local tax or customs?
- “Trade is Open”: Different licenses for domestic and international trade, warehousing, distribution, retail.
- Bank financing availability depends……Size, sector, location, bank quota, time of year, macro-economic controls, relationships and sometimes risk analysis.
- Peak power shortage in east China vs. excess in northeast China: Gas will be piped into east China in the next 2 years. Diesel genesis are in demand. What about availability of diesel fuel?
- Law Reform and legislation: Massive progress and change.
Key Question
- Without Reliable Information (not just “due diligence”), how does one evaluate market demand, competition, opportunities, boom and bust cycles, plan or project allocation of future resources? How does one protect one’s client?
- The answers are not only located in the documents.
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