Published in Asian-mena Counsel: Mergers & Acquisitions Special Report 2020
Making investments or entering into an M&A deal can involve uncertainties and potential pitfalls. These can include financial and commercial issues, clashing business cultures, sudden changes in government regulation, poor strategic fit or simply bad timing, to name a few. Fortunately, shrewd investors and their legal counsel can identify many risk areas early by gaining a deep understanding of the company they will invest into and its surrounding business environment.
Uncovering past track record and existing problems
Common pitfalls can be identified by performing proper investigative due diligence. Most firms know of the need for some due diligence prior to investment, but many limit those investigations to financial, commercial and legal dimensions, with the occasional ‘background check’ thrown in. These efforts are useful for obtaining a baseline as to the company’s past performance, market conditions and other public information on the company and its key management.
These checks do not, however, address big-picture risks that could potentially undermine the longer-term viability of the deal. Many well-known examples demonstrate how ‘routine’ due diligence can be grossly ineffective, despite being audited by reputable global firms, especially in identifying debilitating cultural differences, intentional misreporting and—worse still—outright fraud. The potential ‘traps’ involving companies in emerging or frontier markets can be even more significant.
Another risk for investors is that processes may be rushed, with some management eager to reach a deal as quickly as possible. BRG professionals have uncovered deliberate, multiyear coordinated accounting misconduct by senior management in inflating revenues, leading to a significant overvaluation of companies. The turning of a blind eye to known issues in an attempt to reach a deal quickly is often commonplace.
Although truly robust financial due diligence might identify potential red flags prior to deal closing, questions about key management figures and relationships with customers and external vendors would require a more in-depth exercise. Commercial due diligence and ‘background checks’ are necessary, but they are no substitute for deep-dive investigative due diligence to capture suspicions of wrongdoing, irregularities, regulatory transgressions or other reputational red flags to which prudent investors should pay heed. In many cases, the most troubling information is not a matter of public record and can be obtained only through systematic discreet inquiries with regulatory contacts, business partners and/or individuals who have insight into the company’s ‘dirty laundry’. Investors are often surprised by the volume of valuable information hidden from the public domain.
Assessing the broader business environment
Factors beyond the direct control of a company also have a bearing as to the viability of any business. For example, a deal can be affected by government red tape, local opposition to the project, political conflict within local stakeholders, inconspicuous resistance by factions inside the company or other ‘unwritten rules’ of business. These factors affect companies both foreign and domestic.
Take Tata Motors, a subsidiary of the massive Indian conglomerate Tata Group, as an example. In 2006, it acquired 400 hectares of land in Singur, a small town in West Bengal, to build a factory for its low-cost Nano car, which has sometimes been called the world’s ‘cheapest car.’ The site initially appeared promising, as the state of West Bengal had formulated an industrial policy to support the development of a local automobile industry to solve local unemployment problems. However, when displaced local farmers began to receive compensation checks from the local government following the sale of the site, they quickly grew angry with the low level of compensation offered. A series of protests erupted, which quickly turned violent. Once the first Nanos began rolling off the production line, other local figures began to demand that the bulk of the land be returned to the local farmers. After a lot of wrangling, Tata Motors realised how untenable the plant had become and ultimately decided to leave West Bengal. Unfortunately, its shift of location to Sanand, Gujarat, created a production delay of eighteen months, which coincided with a period of great hype for the innovative vehicles. The political and reputational fallout from the saga haunts Tata Motor’s reputation to the present day.
The importance of properly assessing risks and developing a nuanced understanding of a local environment simply cannot be overstated. If a Tata Group subsidiary can get into such a quagmire in its native country, then a foreign firm hoping to break into a similar market would be wise to assess its prospective business environment diligently and intelligently. Tata Motors’ experience in West Bengal shows that having a good understanding of not only the domestic legal system, but of the nexus between local power brokers, interest groups and political factions, and potential flashpoints is critical prior to making any major investment.
Specialised risk-advisory firms can provide invaluable support in this regard, because detailed insights pertaining to specific sectors and localities are simply not covered by strategy consulting studies, ‘ease of doing business’ reports, or ‘background check’ reports.
The importance of business intelligence
Successful M&A, or indeed any investment, demands a thorough evaluation of all facets of risk surrounding an opportunity. The underlying commercial soundness of the deal, the broader business environment and the likelihood of potential changes to that environment are all important areas to be looked into. Unsurprisingly, the depth of research and level of due diligence demanded by sophisticated investors have expanded immensely in recent years. As we enter into the new decade, firms that continue to rely solely on traditional commercial, legal and financial due diligence will do so at their own peril.
Ranked by Global Investigations Review as one of the world’s top investigations consultancies, BRG’s Global Investigations + Strategic Intelligence practice provides companies, their counsel and other advisors with critical information to make well-informed business and compliance decisions. Our professionals possess a wide range of skills and disciplines and include intelligence experts, forensic accountants, computer forensics and technology consultants, and data analytics specialists, as well as cybersecurity, governance, regulatory, security and industry experts. BRG’s multidisciplinary team has deep experience in consumer goods, energy, financial services, gaming, healthcare, manufacturing, mining and mineral extraction, pharmaceutical, real estate, technology and telecommunications and media. Our professionals have conducted investigations throughout Asia-Pacific. Our teams leverage depth and breadth of experience with sophisticated analytical tools and industry expertise to provide bespoke solutions to complex legal, business and regulatory matters.
The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.