Thorough due diligence is without a doubt the most important step when acquiring a company. While financial and legal due diligence are essential to the process, commercial due diligence is often overlooked and undervalued. Especially in China, the lack of set procedures, documentation, and organisation frequently yields inaccurate information making it necessary to dig deeper than what is written on paper and what is told. You will avoid expensive mistakes down the road if you look past the numbers and understand the bigger picture early on.
If the target company checks out in all of the below indicators, it is in good shape for a future acquisition:
Organisation & ownership: Understanding the organizational set-up and profiling key stakeholders and decision makers will shed light on how the business is run and if it fits with the managing style of your company.
Strategy: Can the company drive sustainable growth? What are their current strategies and more importantly, what were their strategies in the past? These factors can give you a good indication of a companyâs long term viability.
Sales & Marketing: Reviewing distribution set-ups and networks, as well as historic sales performance is essential to make sure that the company can provide a continued stream of income after the take-over. Sales may be through the roof today, but looking at trends and movements in the companyâs history can help avoid flukes.
Operations: The reliability of the supply chain is crucial to ensure that there is no chance the operations will fall apart after acquisition. Full comprehension of how production and inventory management work will give you an idea of how smooth the operations are and if there are any issues that need to be addressed.
Staff: It goes without saying that the quality of the workforce is the cornerstone to a healthy, functioning company. This does not just mean the senior management!
Financials: Yes, thorough financial due diligence follows commercial due diligence, but it still should not be overlooked at this stage. The basic elements should be reviewed to at least rule out the obvious no-noâs when it comes to finances. Additionally, any findings here can be used as a framework for financial due diligence later on.
Relationships: the least straightforward yet most important factor in commercial due diligence is investigating the companyâs external relationships. The complexity of this task is staggering: from assessing the companyâs reputation in the market to examining the impact it has made on the local community, this research is far more comprehensive than simply doing internal interviews or accessing data. The local community and even the government must be asked for feedback. All of this must be carried out with what we call a âclosed approachâ, meaning that the people in question cannot be made aware of the intention behind the interview in order to obtain the most reliable and unbiased responses.
Knowing When to Say No
Recognizing which boxes the target company has to tick in order to give the green light is only half the battle. Clearly defining what the deal breakers are is just as important, especially when doing business in China. For example, what is your tolerance for corruption or environmental negligence? Yes, morally speaking you must be able to draw the line, but also from a macro perspective, the Chinese government has been clamping down on these issues in recent years and we can certainly expect there to be more policies along these lines in the future. China is increasingly conforming to international standards when it comes to business best practices, so turning a blind eye now could result in huge damages not only to your China operations but also to your brand image in general.
Beware of the accounting practices of Chinese companies! Not uncommonly, a company may be keeping 2 or 3 different books with liabilities unknown to you. They may boost their revenue without having the real numbers to back it up. Digging deeper pays off to avoid having the Chinese government charge you with tax evasion or not paying your social security contributions.
Another potential problem can arise from the politics among the staff. Frequently in China, top contracts will go to family members or close friends of senior management, unrelated to merit. These sensitive relationships could pose a huge risk to you and the retention of your staff later on. Moreover, there is often a general sense of panic and insecurity among the ranks, once it surfaces that there are talks of an M&A transaction. If most of them are migrant workers, they may all have left before you even signed the papers. We recommend to cross-check internal and external sources to shed light on any discrepancies.
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