We all do our due diligence (DD) at home and Chinese businesses always conduct due diligence on each other so it is surprising that so many foreign businesses get to quite late stage deal negotiation without conducting even the most rudimentary checks.
In answer to the questions of when and how, it’s best to think of DD as a form of insurance against your potential investment, thus the amount of DD you conduct should be directly proportionate to the size of the investment risk and just like insurance you should take it out before the next round of activity.
Let’s imagine you attend a trade fair or exhibition in China, your CEO has given an important speech outlining your company's bona fides and because you’re a high quality operation you have generated lots of initial conversations and ended up with around 200 business cards. Now probably about 150 of these are casual conversations that require no follow up. Probably 30 or 40 are “not sures.” What you do with these probably depends on your strategy. This leaves 10-20 new introductions that seem initially promising. You manage to get some further meetings and fly home with a list of five that you think are good leads.
So let’s think about what happens now. Maybe you exchange a few emails or perhaps a call but eventually you will need to go back to China which is quite an investment on top of what you paid for your first trip. There are flights, hotels, subsistence, interpreters etc so let’s say around £5,000-£10,000 plus the opportunity costs of having senior team members away.
At this stage it is almost certainly worth checking at least if the company you are dealing with is real by conducting some basic checks. This won’t tell you if the deal is there to be done but might well tell you enough to know there is no point in any further investment.
Clearly as the conversation, number of visits and level of engagement increases you will want to consider the next level of desktop due diligence with a fuller report. This triangulates everything you have been told with a wide range of searches and look for any inconsistencies or red flags (legal or reputational). You may also want to ask for a copy of the business licence and company accounts at this stage.
This is as much as you can do as a desktop exercise but from there why not check out the companies’ facilities, talk to suppliers, customers or competitors and get as full a picture as possible.
After that of course you will need a Chinese lawyer to help construct the deal which we have written about in China Contracts – Why Chinese Law is on your Side.
Keep the level of DD proportionate to the level of time and money you are putting at risk and you are likely to fair well in China. No one will be offended that you are doing this. It shows you are both serious and canny and that will help you in your downstream negotiations.
Lastly if you skipped DD in your dealings in China you are already exposed both financially and reputationally – yes it may be going well now but you may take a different view if it turns out there are legal or reputational issues you were unaware of. Do you want to be the person explaining to the Board what has happened if something goes wrong – someone is sure to ask about DD then !