Ascertain company value of M&A targets
Ascertain company value of M&A targets
In western society, motives are like the skin on an apple, peel it off and
you’ll find the hidden motive. Not so in China: here you’re dealing with an
onion – with many layers. Therefore it is of substantial importance to ascertain
the company value of your M&A target. Otherwise many unpleasant surprises may
occur.
Such surprises can include that the target’s accounts are not managed
correctly or that it doesn’t own buildings or land use rights as it is supposed
to. These and other results of wrong preparation and valuation can be read daily
in the newspapers. The following questions give an approach on how to tackle
this issue and avoid unexpected inconveniences:
- What is “Company Value”?
- Why is it necessary to ascertain company value?
- How do we ascertain company value?
What is “Company Value” ?
There are two common classifications of value:
- The tangible value (e.g. Accounts receivable, machines, factory, land, raw
materials, IPR etc.) is the value, which is quantifiable since they exist in
the form of balance sheets, annual financial statements or invoices.
- The other is the intangible value (e.g. staff knowledge, databases &
business contacts, relationship network etc.), which is difficult to access in
numeric form.
Why is it necessary to ascertain company value ?
It can be difficult to get a close view into, for example, state owned
enterprises as they have a very complex company structure.
Although some information is provided, in most cases it comes from various
sources.
The level of information from privately-owned companies is often not up to
international standards. Therefore cross-checking is necessary before it can be
seen as credible.
How do we ascertain company value ?
The chart below shows a structured approach in ascertaining the true value.
Due Diligence
Due diligence is the way in which a company’s true value can be assessed. In
general, there are 3 different forms of due diligence that are necessary to be
performed, namely;
- Legal due diligence
- Financial due diligence
- Commercial due diligence
Additionally, there are other forms of due diligence, which depend on the
business nature, therefore they can vary respectively. People always tend to overlook the importance of commercial due diligence,
which significantly determines the M&A progress.
In order to find the most valuable company in China for your M&A purpose, it
is suggested to have a proper look from 3 different angles:
- Internal current performance of target itself
- Current activity of external factors
- Future strategy of target and network
It is necessary to get a clear overview of the object’s current performance,
but also to include external factors. Strategic plans can include future implementations regarding structure,
sales, organization, marketing and human resources. Therefore they need to be
seen as an important factor within the evaluation.
The following are some major areas that need to be assessed in the commercial
due diligence:
Operations
A company producing goods or offering services in China is only allowed to
do so to the extent described in the business license. Since the business
license can’t be changed, it needs to be checked very carefully before the deal.
The next step of the evaluation is to explore which operations are handled in
house and which ones are outsourced.
Products and Process
Here it is necessary to analyze the main products, production technology
level, the current Know-How and what special machinery and equipment is needed
in order to maintain production. The products, production technology, licenses
and product quality of the target need to be checked to see whether they match
with the future needs of the buyer.
Suppliers
The quality of suppliers as well as their relationship with the target needs
to be investigated. Any special purchasing pattern, such as long-term contracts
or special relationships between the target and suppliers, should be assessed
properly in order to reduce hidden risks.
Customers, Sales and Marketing
Customer relationships are a significant driver for turnover and growth.
Since it traditionally takes more time to win customers than to maintain them,
the buying company needs to identify the target’s customer service and get a
clear overview of the sales department.
Additionally, because of the huge size of the country, it needs to be clear,
which areas are covered regarding sales and marketing. To judge the target’s
competitiveness in the market, it is possible to, for example, benchmark against
the market leader to point out where to improve in order to offer better service
and customer satisfaction.
Distribution
A well established distribution system is crucial and a major objective for
acquiring a company in China. Therefore the first goal regarding this topic is
to obtain a clear overview of the existing distribution network, its
reliability, quality of performance and relevant issues like logistic
arrangements and duration of delivery.
The quality of information flow has net yet reached global standards. Most of
the companies are weak in executing necessary changes. External help is usually
needed to ensure that information is accurate and cross-checking is properly
done.
Research and Development
It is crucial for companies that are product or services driven to always be
researching and developing new and innovative products or services for their
market. When assessing a company it is important to look at their research and
development initiative. What innovative capabilities does the firm possess? The
budget reserved for R&D serves as an indicator in reflecting the company’s
effort. It is also possible that R&D is outsourced (e.g. to University or
cooperative R&D centre), and if so the lengths of the contracts with these
partners need to be identified. What is the quality level of their R&D staff,
and what kind of staff turnover do they have. It is also important to look at
the difference in technology levels, as compared inside China and to the
international market.
Personnel
Improper practices in personnel issues would lead to serious losses on both
legitimate and business considerations. Thus a careful assessment is to reduce
any legal or business risks. Legitimately, strict rule applies on whether a person has the right to work
in certain geographic areas in China. The availability of a proper staff record
not only shows the efficiency of the administration, but also helps to reduce
the unnecessary legal responsibility after merger or acquisition.
From the business perspective, high staff turnover rate would definitely
affect the productivity of the business, which also reflects the incapability of
the top management. The existence of loyalty group would create strong
opposition to changes after the acquisition; therefore this has to be discovered
and handled carefully. Fail to do so may lead to disastrous consequence,
especially if senior/key staff are involved and eventually leave the company.
The availability of staff retention measures would help to reduce the risk.
Due to cultural background in China the top management holds absolute power
in all aspects of a business. A thorough investigation on the management
structure is essential: Are there any interrelationships between members of the
management team? Who is the key decision maker that is critical for the merger
or acquisition?
The quality of information flow has not yet reached global standards. Most of
the companies are weak in executing necessary changes. External help is usually
needed to ensure that information is accurate and cross-checking is properly
done
If you would like to know more about the due
diligence process in China, please contact
Mr. Heiko Bugs (email hbugs@fiducia-china.com tel: (+852) 2528 2259).
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