Understanding the business and the legal framework of the target company is especially important in China. Standard questions should still, therefore, be asked in relation to longer term contracts, supplier and customer arrangements, intellectual property, real estate, litigation and employment. Without asking for such information it will be almost impossible to assess the risks associated with dealing with the Chinese counterparty.

Unlike many foreign companies which have well-documented business arrangements, information obtained from management discussions can often give a clearer insight into how a Chinese company is run. It is valuable to arrange sufficient time to meet with key management personnel. From those discussions, it will be possible to put the documents provided in context. Management sometimes refers to aspects of the business which are not covered by the documents provided, which can also enable a more targeted due diligence exercise.

Jack Wang
Partner
Freshfields Bruckhaus Deringer

The domestic perspective

For a sizeable China transaction, usually people know about hiring one of the big four accounting firms plus a large law firm, because they are said to be required. On the other hand, many of the so-called business issues – such as the local partner's claim of influence with the provincial government, or the target's claim of being the largest supplier of a material in northern China – do not get the same degree of professional attention. Regardless, to me it's generally not the coverage of the due diligence that people do in China, but the extent to which people trust the local parties' claims or information in the covered due diligence, that has caused many issues during and after transactions.

My view is that when you conduct due diligence on a company in China, for the issues that really matter to you: avoid blindly trusting the words or information given by the target's managers, or even many third-party local agencies. Target management has an implicit conflict of interest with you. Many local agencies can be influenced to be less neutral than desired. Responses to due diligence checklists are seldom complete the first time. Problematic documents are often hidden unless specifically requested by experienced professionals. Too many inexperienced investigators just robotically go through their checklists – “Has your company exceeded the legal maximum working hours? No? [Check.] Taken or given bribes? No? [Check.] … OK, thanks for your time.” Truth is never found so easily at face value.

To find the real facts: send your own trusted employees (or go yourself) for a personal visit, and pay attention to things people try to hide from your visit path. Have anonymous interviews with employees or local people around the factory. Try all the online or offline information sources you can find. Send everything you get to experienced professionals for them to analyse. Your team must be creative in collecting every piece of information, be diligent in looking between the lines for inconsistencies, and be resolute in grilling people and checking everything against opinions from your own professionals, until you get to the bottom of the issues you really care about.

Richard C Lee
Senior counsel
AllBright Law Offices

The specialist perspective

Ideally, independent investigative due diligence, financial and legal due diligence should be carried out in parallel because they all address different aspects of the transaction. The results from these due diligence efforts, when reviewed in combination, will arm the investors with the necessary intelligence with which to make sound business decisions and mitigate risks.

However, when time and budget is of real concern, investigative due diligence is probably the most efficient way to get fundamentally important information. Investigative due diligence is unique because: (i) Unlike financial and legal due diligence which greatly relies on information provided by the subjects, investigative due diligence is carried out independently with information obtained through public records, media sources, and well-placed human sources. As such, the results are not influenced by information inaccuracy or fabrication on the part of the subject; (ii) Investigative due diligence focuses on the people behind the scenes, and their backgrounds and reputations. Such emphasis means that you will be geared to uncover things that may be categorised as deal killers.

While there are some common issues of which investors should have sufficient understanding regardless of where the investment takes place, the following are some issues that are of particular importance when performing due diligence in China:

• It is not uncommon for investors to have tunnel vision and to limit their due diligence strictly to the entity in which they are considering investing. It is always helpful to understand the overall structure of the group and the interrelationships among various member companies of the group in order to determine if there are any cross-liability issues and the real reason behind the financing efforts. It is also important to identify undisclosed commercial interests, whether directly owned or through family members or other nominees, particularly those that may pose potential conflicts of interest.
• It is important to understand the nature of the relationship between the subject and the key government regulators. Keep in mind that that today's political assets may very well be tomorrow's political liabilities, if the relationships are based on bribery and corruption instead of institutional support and good will.
• Reputation of the key principals: How did they make their first bucket of gold? Do they renege on promises? Are they associated with individuals of ill repute? Do they have a controversial lifestyle or business acumen? Most of these questions can only be addressed through discreet human source inquiry which is unique to investigative due diligence.

Violet Ho
Managing director
Kroll