Integrity Due Diligence

Identifying Risks When Investing in New Business Relationships

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By Tim Klatte, Partner, Forensic Advisory Services

For any organization with investments in China, whether it be through operations, suppliers, buyers, or other business partners, it is absolutely critical to conduct viable due diligence checks. In fact, Integrity Due Diligence (IDD) has been a topic of continued interest for multinational corporations (MNCs) in China since investment first began decades ago.

Like doing business in any developing country, evaluating the background, activities, and overall reputation of your target companies or counterparts is an essential step that is often overlooked. Through the IDD process, one may be able to detect – in advance – any possible corrupt activities or reputational issues before committing to a new business relationship. Simply stated, IDD findings may influence a decision whether to go forward, reconsider, or stop a deal, and it is important to take a local approach at all times.

Due Diligence with Chinese Characteristics

An IDD project in China often begins with collecting basic information about the subjects in question, such as their names, titles, positions and other identifiable information that can be provided by the client. The next step is to search public records using keywords, based on other information already in hand. These public records searches can uncover information about the subject’s education, job history, and associations.

This phase of the research may also reveal involvement in public cases or with known criminal or politically exposed organizations. Occasionally, information revealed in the public records searches will call for human source inquiries by knowledgeable persons in the subject’s industry, or someone with knowledge of associations with whom the subject is involved. IDD uses a combination of public records searches, human sources inquiries, and in-house industry knowledge or domain expertise to provide solutions to clients.

At all times, IDD professionals must be aware of and knowledgeable about the environment in which a project is proceeding, must understand what procedures are allowed under the local law, and know which sources are most reliable. Each operating environment is unique and working with a reputable firm can guarantee that the information is valid, reliable, and collected legally and ethically.

 

Why Integrity Due Diligence?

For companies planning to enter China, whether by acquisition or by a joint-venture agreement, as well as those with existing operations in China, IDD is critical for understanding what risks integrity issues may pose to their business. These issues may impact deal conditions, company valuation, and operations after the sale.

These integrity issues also may result in unforeseen costs; from an MNC perspective, they present the risk of broad reputational damage both in China and overseas. To resolve these problems before they begin, an IDD check will allow organizations to discover information that would indicate whether the organization and its brand are subject to any of these risks.

To illustrate the multifaceted types of risks that can be defrayed by a thorough IDD search, consider a recent experience. A client requested an IDD search on all employees of a manager level and above at a local company before a JV was to take place. GrantThornton’s team discovered, through a combination of public searches and discreet inquiries, that three of the managers were also working for a competing firm in a part-time capacity. Needless to say, this evidence prompted immediate client actions, avoiding a much more serious (and costly) situation that likely would have materialized if the client had not requested the IDD search.

Emerging Risks

Clients often expect to know a variety of information regarding prospective business partners in China. First, understanding a prospective partner’s business history, track record, and overall reputation of their principals is critical. Next, potential red flags may exist, such as involvement in corruption, bribery, fraud or other crime.

It is also important to be aware of political relationships and political support and any use thereof – especially in China. Hidden influencers over a company, such as hidden shareholders or political figures, may exist. Finally, knowing undisclosed business interests or conflicts of interest in advance can intercept corruption before it becomes an unresolvable problem. The variety and complexity of risks for MNCs in China are the reasons why seasoned professionals often advise clients that a few pennies spent in the pre-transaction Due Diligence process can save more than a few dollars once the deal has been finalized with the business partner.

Tim Klatte is currently a Forensic Advisory Services Partner in Grant Thornton and Head of the Shanghai Forensic Practice. He has extensive leadership experience in due diligence investigations, business and competitive intelligence, and China macro/micro economic forces that shape boardroom decisions and foreign policy. Tim has conducted more than 250 investigations and corporate intelligence projects across multiple industries and in all regions of China. For more information, please contact him via email.