Due Diligence in China E-Book

Kwek Ping Yong

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Corporate F&A
• Sprache: Englisch

Seitenzahl: 634

Veröffentlichungsjahr: 2013

Beschreibung

A plain-English guide that demystifies the business landscape in China from a due diligence point of view Due diligence is crucial to any business deal, and, thankfully, due diligence research has come a long way over the years. What used to be a cumbersome, time-consuming process has been standardized and systemized with generally accepted auditing frameworks and tools, such as the all-important auditing "checklists." But when it comes to doing due diligence in China, with its opaque regulatory system and byzantine accounting standards, all bets are off. In this book an acknowledged expert in the field takes you beyond the checklists to arm you with China-specific due diligence strategies, tools and techniques that go beyond what is typically part of the process. * Gives a detailed account of why conventional frameworks used in the west simply don't work in China * Provides first-hand accounts based on the author's years of experience as a private equity professional doing deals in China * Reviews, in-depth, the unique differences between corporations and businesses in China and those in the West and their implications for the due diligence process * Uses numerous case studies to guide the reader through an entire due diligence process for a firm in China

Leseprobe

Contents

Preface

Acknowledgments

Chapter 1: The Business Landscape in China

Macro and Structural Domains

Corruption in China

Conducting Due Diligence in China versus Western Countries

Conclusion

Notes

Chapter 2: Due Diligence in China

Due Diligence for Different Types of Deals

Levels of Due Diligence

Key Considerations

Organization of Due Diligence Process

The Due Diligence Team

Independence of Vendor Due Diligence

Reasons for Poor Due Diligence

Reverse Takeovers

Dispute between SEC and CSRC

Conclusion

Notes

Chapter 3: Financial Due Diligence

Financial Due Diligence Checklist

Conclusion

Notes

Chapter 4: Operational, Commercial, Legal, and Other Due Diligence

Operational Due Diligence

Commercial Due Diligence

Legal Due Diligence

Balanced Scorecard (BSC)

How to Predict Bankruptcy—Altman Z Scores and Gearing

Optional Checklists

Conclusion

Notes

Chapter 5: Beyond the Checklists: Founder and Management

Founder Management Root

The Founder Background Check

Guanxi (Relationship)

Due Diligence on More Than One Founder

Summary of Background Check: SWOPEST and Tri-Background

Conclusion

Notes

Chapter 6: Beyond the Checklists: Hard Facts

Face-to-Face Meetings

Proportion Check

Site Visits

Due Diligence Goes One Step Deeper: The Four Deadly A’s

Conclusion

Notes

Chapter 7: Implementing a Due Diligence Workflow

Getting the Mind-Set Right

Formulating the Due Diligence Strategy

Forming a Team

Starting the Due Diligence Process

Conclusion

Notes

Chapter 8: Post Due Diligence and Case Studies

Preparing the Due Diligence Report

Due Diligence Outcome Review

Deal Structuring, Negotiation, and Deal Making

Post-Acquisition Due Diligence

Summary Models

Final Case Studies

Conclusion

Notes

About the Website

About the Author

Index

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ISBN 978-1-118-46906-4 (Hardcover)

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ISBN 978-1-118-46905-7 (ePub)

To

My Family

For your unreserved support with my stay in China for so many years

To

Kelvin Fu

Joshua Lim

For your talents and hard work

Preface

Conducting due diligence is both an art and a science. We argue that the due diligence process in China is more art, as there are more subtleties but less black-and-white, number-crunching processes. Due diligence checklists are frequently relied on by many legal, accounting, and financial institutions as a methodology to conduct due diligence in companies, these checklists typically cover the basic due diligence areas, and some firms may have refined the checklists based on their own in-house expertise and experience in the industry. Yet, judging from the number of financial blowups and fraud cases in China and around the world, one inadvertently comes to the conclusion that the due diligence checks conducted by these professional services accounting and financial institutions are inadequate and have failed to uncover these spectacular financial disasters. To this end, the central position of this book is to argue that one must go beyond the due diligence checklists in order to attain a more comprehensive and more reliable assessment of the target company in China.

Due Diligence in China: Beyond the Checklists is the first book that goes beyond the scope of what most readers are familiar with in a typical checklist. Going beyond the checklists requires an in-depth understanding of the relationships between all the entities present in a typical Chinese company. This could run the gamut of personal, professional, political, and social relations between internal peoples/groups and external parties. This book utilizes real-life case studies that were developed specially for this book. These case studies are meant to provoke the readers to delve deeper into the intricacies of conducting due diligence in companies operating in China and also to provoke the readers to garner valuable lessons from the colorful history of companies and deals gone badly.

The first chapter of this book, “The Business Landscape in China,” sets the stage for the rest of the book. In this chapter, we discuss the business landscape in China. Indeed, there are many books out there that attempt to describe this topic. However, this chapter is meant for readers who are relatively new to China and want to have a basic understanding of the basic business environment and the unique characteristics of doing business in China. A discussion of the business landscape of China includes the political, social, and cultural aspects that are often neglected when one considers doing business in China. Understanding the business landscape will provide readers with a good contextual understanding of why conducting due diligence in China needs to be deliberately and meticulously planned and why it is so critical prior to deal making to maximize the chances of success in the deal.

In the second chapter, “Due Diligence in China,” we discuss the basic due diligence process in China. We also discuss the differences in the types of due diligence conducted. It is critical to understand that the nature of the due diligence will affect the type of due diligence conducted. There are significant differences between conducting due diligence on M&A transactions and on private equity investments, for example. We also identify the shortcomings of these checklists pertaining specifically to Chinese businesses, so as to provide readers with a good understanding that relying on checklists alone to conduct due diligence is not advisable, and could be also highly risky, as the results of the due diligence would not be an accurate reflection of the true state of any Chinese company. This chapter also includes a discussion of the differences of due diligence conducted in China versus the West. Readers will find that while the processes for due diligence are generally similar in different countries, there are significant differences in the approaches and mind-set that one must adopt in conducting due diligence in China especially, because of the differences in the business landscape and political system.

In the third and fourth chapters, “Financial Due Diligence” and “Operational, Commercial, Legal, and Other Due Diligence,” we discuss the conventional due diligence checklists that are typically involved in deal making. There are many different types of checklists used by different service providers for different industries. These two chapters list items on the checklist that are most pertinent to conducting due diligence in China and what are the key things to look out for when going through the checklists.

The fifth and sixth chapters discuss in depth the ways to overcome the shortcomings of the conventional checklists—that is, how to go beyond the checklists in order to get a truer reflection of the state of the Chinese company. We will be introducing many different applications of these unconventional methods of due diligence and its impact on the company. The fundamental basis of a due diligence that goes beyond the checklists is to ensure that no stone is left unturned no matter how uncomfortable or awkward the process can be. However, this oversimplifies things. Readers, by now, should be asking the key question: Are there other stones that we did not know of in the first place? This is a fundamental question that any type of due diligence that goes beyond the checklists should ask and explore deeply.

The fifth chapter, “Beyond the Checklists: Founder and Management,” focuses on the conduct of due diligence on key executives of the company. This human due diligence is especially critical in China, as the founders and high-level management wield enormous influence in the company. We also examine in detail the personal lives and relationships of the executives, which may turn out to be potential liabilities and risk factors to the company.

The sixth chapter, “Beyond the Checklists: Hard Facts,” lays out the importance of verifying the hard facts through face-to-face meetings, site visits, and proportion checks. These methods require investing a significant amount of resources, time, and experience to carry out. We also discuss about the four deadly A’s that one has to contend with during the due diligence process: Authorization and control; Abnormalities; Anti-corruption and bribery; and Accounting frauds and cheats. Lastly, we would introduce the Anti-Corruption Investigate Due Diligence (ACID) framework and show how it could be utilized to guide the process of doing due diligence that is beyond the checklist.

The seventh chapter, “Implementing a Due Diligence Workflow,” features a useful practical guide for readers who may be conducting a first-time due diligence exercise in China, or for readers who want to deepen and broaden their knowledge about the effective ways of doing due diligence in China from the planning stage and forming a team onwards.

The eighth chapter, “Post Due Diligence and Case Studies,” deals with the tasks upon completion of the due diligence formal process—namely, the preparation of the due diligence report, conducting the post due diligence review, and, if the deal were to go through, the conducting of the post deal monitoring process. Additional case studies have been included to allow readers the opportunity to apply the methodologies introduced in going beyond the checklists and to compare and contrast both outcomes. Through this exercise, the readers will be able to better appreciate the comprehensiveness and detail required when conducting due diligence in China.

Throughout the book, some terms are used interchangeably, for example, investors and acquirers, founders and entrepreneurs; they are in general referring to the buyer or the seller side of an acquisition or investment deal respectively.

As usual, case studies used in this book are to demonstrate main points highlighted and discussed in the chapters. It is not a show of good or bad decision making, strategy, or management on the part of those parties involved. There is also no right or wrong “answers” to these cases. Furthermore, remember that one does not have the full insider information of the situation. They only serve as a trigger to the readers to think deeper into any similar scenario they may face, and as far as possible, the readers should try to apply the methodologies and models discussed in this book to these case studies and maybe go one step further, applying them to the readers’ own cases.

A good due diligence needs to be highly customized according to the objectives and nature of the investment or acquisition. There are two Appendices on the companion website. In Appendix A, we have included due diligence checklists on financial, tax, operational, legal and environmental that could be used as guides for the due diligence process.

In Appendix B, we have included proprietary tools and diagrams that go beyond the checklist (Appendix A) that readers could use to enhance their due diligence process. These tools and diagrams are only the skeletal framework and deliberately kept blank so that readers could utilise them as worksheets. In order to utilise these checklists, tools and diagrams effectively, readers must go through individual chapters to understand its context and how they could be applied for their own use.

Lastly, readers can visit the author’s Website at http://www.ddinchina.com for the latest updates on the book, due diligence related information and to download the soft copies of the checklists, tools and diagrams. Likewise, the book’s companion Website is http://www.wiley.com/go/ddinchina, and the password is yong123.

Acknowledgments

Writing this book was more difficult than I thought it would be, but I am really fortunate to have a group of very capable professionals and friends who helped me along the writing journey.

Once again, I am most grateful and indebted to Kelvin Fu and Joshua Lim. This is the second book we have worked together on. They were both instrumental in getting this project sailing smoothly. Kelvin and Joshua helped me tremendously in the structure and content of this book and gave me invaluable suggestions and constructive comments during the writing and editing process. I know very well that they both have sacrificed lots of personal time for this book. In fact, the many methodologies and models used in this book were also the hard work and brain child of Kelvin and Joshua’s field work with me in China, when we went through the due diligence process of many Chinese companies in different cities and sectors. They were the ones who transposed many difficult and complicated due diligence processes into easy-to-understand yet rigorous models that we are still using today. Time has proven that our models worked so well that we do not have a single failure in our investment history in China. I dedicate this book wholeheartedly to these two extraordinary young friends of mine.

I have an excellent research team who helped me in researching all of the case studies featured in this book. I am very thankful to Yeo Zhi Wei and Zhou Peng Hui, who have spent many sleepless nights discussing cases with me after our busy daily schedule in Shanghai or anywhere in the world when we were traveling together. They are both the most talented, energetic, and passionate young professionals we have in our office.

Joshua Lim and Zhou Peng Hui will be living in Philadelphia and Boston respectively for the next few years. I wish them a good stay and enjoyable learning experience.

Whenever I received drawings from Kenny Ng for the illustration of some major points in this book, I had a jolly good laugh. I noticed Kenny’s talent in drawing many years ago and I am so privileged and thankful for the bit of humor Kenny adds to this book.

Thanks also go to Chen Heng Hui and Evan Foo for their assistance with the case studies, and James Guk for the nicely drawn diagrams and flowcharts.

I thank Kelvin Koh for his warm hospitality when I was in Seoul writing the final part of the first manuscript for submission to my Wiley editor.

I sincerely appreciate and felt the professionalism from the John Wiley & Sons team. This book would have been absolutely impossible without the support from Nick Wallwork and Nick Melchior. Gemma Rosey is the most helpful and greatest editor, who has guided me through the writing process and Chris Gage, has been so patient and thoughtful during the production stage. Thank you very much.

To my family again, I sincerely thank them for letting me living in China for more than a decade. Without this experience in China and the long stay there, this book would not be possible.

Chapter 1

The Business Landscape in China

This chapter is designed to provide a broad overview of the business landscape in China. Without a fundamental understanding of the key components that make up the business landscape, readers may find it hard to understand the intricacies of doing business in China and how it relates to the core topic of conducting due diligence in China.

Conducting due diligence in China requires an intimate understanding of the business landscape in China and understanding how these various factors interact together to pose challenges. An in-depth due diligence is critical in helping potential buyers to identify the workings of a company and its strategy, and to uncover any hidden issues.

In this chapter, we discuss the characteristics of Chinese political, business, and social landscapes and their relevance and impacts to the due diligence process. The three landscapes are inherently wide in scope and cannot easily be exhaustively covered as they are also dynamic and changing with the times. The purpose is to inform readers to pay attention to the context and unique circumstances that surround Chinese due diligence. The landscapes described may share some similarities with other regions or countries, but, seen as a whole, the Chinese characteristics of these landscapes are unique to China.

First, we cover the macro and structural domains that include a discussion on the macroeconomic conditions and system of rules and laws in China. We also cover the level of corruption in China and the significant number of fraud cases that plague business dealings in China.

Second, we cover company-specific issues such as the lack of internal controls of Chinese companies that have made it more susceptible to corruption, backroom dealings, and dubious related-party transactions. We would also discuss the current state of how Chinese businesses operate in general, which is to say that they rely heavily on manually intensive record keeping. Moreover, we discuss the cultural and social aspects of the Chinese businesses, which include the corporate culture and environment, the powerful influence of Chinese founders, and their peculiar characteristics that shape their own corporate landscapes.

The aspects discussed in this section are merely snapshots and highlights of the highly complex business landscape in China. As such, readers may find many other peculiar aspects of doing business in China that may complicate the due diligence process that are not covered here. Nevertheless, the purpose of describing the business landscape in China is to provide readers with a contextual understanding and appreciation of the complexities of doing business in China. These insights will provide readers with a good background and allow them to understand and appreciate the importance of conducting a full diligence prior to any deal making in China.

MACRO AND STRUCTURAL DOMAINS

This section covers selected macroeconomic conditions in China that have contributed to the challenges that one may encounter when doing due diligence in China. Some of these conditions, such as the systemic low-compensation schemes, may have exacerbated the level of corruption and fraud cases in China.

From Planned Economy to Market Economy

China has advanced tremendously economically ever since Deng Xiaoping’s economic reform that began in 1978. That reform was accelerated by China’s accession into the World Trade Organization in 2001. Since then, China has been transitioning from a planned economy to a market economy (Figure 1.1). China’s economic growth has been so tremendous that it had surpassed Japan as the world’s second largest economy, and it is poised to surpass the United States by 2027, according to Jim O’Neill, the head of Goldman Sachs Asset Management.1

FIGURE 1.1 The Transition from Planned to Market Economy in China

Source: Illustration by Kenny Ng.

China had been known as a cheap manufacturing haven among investors and businesses looking to leverage the country’s cheap factors of production, such as labor, and government policies. As China’s economy embarks onto the next stage of growth, since its identity as a manufacturing hub, it is gradually evolving into an economy that is more service centric and higher up in the supply chain. The Chinese government has embarked on deliberate measures in the form of strategic economic goal setting using the Five-Year Plans that outline its economic development initiatives. These Five-Year Plans serve as critical benchmarks that the Chinese government strives to achieve, and these changes present great opportunities to investors and businesses.