Business Due Diligence for Offshore Investments: Details That Matter

Business Due Diligence (BDD) is a standard assessment of a company for independent and unbiased detection of risks before its acquisition. It shouldn’t be called  “formal” but rather “essential” –  because it provides critically important information for the potential investor.

Business Due Diligence’s depth and scope may vary. The prospective buyer or investor receives information on:

  • the financial health of the target company 
  • its past performance 
  • the current market position 
  • its opportunities and prospects. 

Such an in-depth review is an optional service available on request (you can send your request to our e-mail address given above this article). After the BDD analysis, InternationalWealth experts will submit to you a fact-based unbiased 360-degree report, so you can make an informed balanced decision and avoid possible risks.

Due Diligence

Introduction to Business Due Diligence

Most often, Business Due Diligence is conducted before major contracts and transactions, such as share purchases, mergers, acquisition of ownership, or solid investments. In some jurisdictions where market participants’ relations, as well as all commercial activities, are regulated by law, Due Diligence is a de facto standard, even when requirements for Due Diligence are not mandatory.

In many circumstances, Business Due Diligence is often perceived as an optional recommendation associated with extra costs. That’s why the legal Due Diligence of transactions is eagerly neglected by many.  Afterwards, it is too late for remorse and regrets. We therefore strongly recommend that you should never sacrifice the BDD check for reasons of ‘saving money’. And even more so, you should not consider our offer of Due Diligence services as a sales pitch.

InternationalWealth portal experts act in the interest of clients. We do not use dubious ploys and quasi-legal options. Business Due Diligence is an extremely important provision for your business security. It allows you to assess the legal validity of the transaction at a modest cost. You can learn about the details of this package offer and ask specific questions about Due Diligence during a FREE one-on-one consultation with our experts. To book this session, please send us your request and a brief outline of questions you need to discuss. The e-mail address is given above this article.

Historical background of Business Due Diligence

Business Due Diligence is one of the types of Legal Due Diligence. Some experts call this procedure an investigation, other words such as ‘analysis’, ‘research’, ‘check’, ‘screening’, ‘clearance’ may also apply. 

A company’s legal compliance clearance has become an essential part of any decent business since 1933 when the Securities Act was passed in the USA after the Great Depression. The Act drew a line under the wild market.  Dealers and brokers have been deemed legally liable for the financial instruments they sell. Violation of the law was treated as a serious offense and was subject to criminal (!) prosecution. This was the dawn of the current Business Due Diligence.

Key provisions of the Securities Act (in one form or another, they are still used in legal investigations):

  • The investor has the right (but not the obligation) to request and conduct the Due Diligence on securities (shares) using the data from publicly available resources.
  • Similar opportunities can be used when conducting Business Due Diligence on other assets.
  • When analyzing a specific situation over some period, the study of numerical indicators (financial metrics) is very important, especially if they are compared with similar data about competitors.

The above-mentioned Securities Act defined the personal liability of each broker/dealer. However, they were left unprotected against unfair prosecution. Even the authors of the Securities Act recognized that omission. The problem was that when referring to the concept of Due Diligence, the difference between ‘non-disclosure’ and ‘concealment’ remained unclear. Consequently, it was very difficult to establish why an investor would not receive all the information envisaged by the law.

In the end, it was decided that dealers/brokers would not be held personally liable if they exercised Due Diligence and disclosed all the information they had regarding the transaction. That was tricky because the disclosure of all the data one has is not the same as the disclosure of all the data that the client was entitled (!) to receive.

Business Due Diligence checklist

  • Due Diligence can be performed by companies, stock market analysts, brokers, dealers, and individual investors.
  • The legal investigation is optional (see below).
  • Brokers are required to initiate Business Due Diligence on the securities (shares) they hold before transferring (selling) them to another person.

Please note: most of the Due Diligence tips and recommendations relate to financial markets. They apply to stocks and (to a lesser extent) to bonds, real estate, and other investment instruments.

It would be easy for us to tell you about the concept of a legal investigation in general, focus on some details, give some examples, make references to legislation, and recommend a  strategy of action. But it is absolutely clear to us that such a broad-brush picture would be of little use to you if you need specific answers to your particular questions.

That is why let us focus on the most practical aspects of investment decisions – those related to Business Due Diligence on stocks.

Stage 1. Capitalization analysis 

  • This exercise generates data on the value of the company’s shares, their price volatility, the ownership rights, and the potential market share of the target company.
  • Large-cap companies usually deserve more trust in their reliability, predictability of financial flows, and investor interest. The flip side of the coin is somewhat lower volatility.
  • Businesses Due Diligence is much more important for medium and small companies because the fluctuations of the stock prices are more pronounced and the risks are greater. Therefore, Due Diligence needs to be more extensive for SMEs. 

Stage 2. Revenues, profits, margin trends, competitors

  • The relevant data can be obtained from the financial statements of the company.
  • Of greater importance in terms of a legal investigation are historical reports covering a specific period, especially in combination/comparison with the analysis of general trends.
  • When ordering a Business Due Diligence review, please focus on profit margins and how they change (rise/fall) over several quarters/years. It would be also useful to compare your data with information about other companies engaged in the same business.
  • Be sure to measure your profits against those of your competitors. This is a way to benchmark players in a particular market sector and to understand trends across the entire industry.
  • Business Due Diligence as a general review of the company is a critically important method but not the only tool. If you choose a more in-depth analysis with a focus on particular parameters and variables it will provide a bigger scope of information for decision making but can be much more costly and more time-intensive than BDD. That is why we recommend Business Due Diligence as an optimal solution.

Stage 3. Specific valuation

  • If there are restrictions in terms of budget, time, narrow business specialization, you can and should analyze standard rating ratios – P/E (price-to-earnings), PEG (price/earnings to growth), P/S (price-to-sales). As a last resort, they can be computed by using publicly available services.
  • The P/E ratio in Business Due Diligence is an indicator of short-term expectations (the price implicit in the stock price). We usually recommend an analysis of this indicator in dynamics – to be able to take fluctuations into account.
  • The PEG indicator is an indicator of the speculative valuation of the company’s stock. It sizes up investors’ expectations of future profits. 
  • Another useful multiplier for Business Due Diligence is P/B (price-to-book). It shows the approximate valuation of the company as it relates to its debts (liabilities), annual revenues, and balance sheet. Please note that P/B is industry-specific, so it should be assessed accordingly.

Stage 4. Management and ownership

  • The owners of the company can be both its founders and other people. Partial ownership is possible.
  • If a company has been on the market for a long time but is managed (directly or indirectly) by the founders, more often than not it shows a lack of flexibility in making strategic/tactical decisions.
  • You can refer to official sources for information about the professional background and competence of the executive members.
  • If the management staff changes frequently, it may indicate the instability of the company. This is where the advantages of Business Due Diligence come into play, rather than the typical standard Due Diligence. The standard DD does not yield an expert opinion based on a legal investigation of all the available factors.

Stage 5. Balance

  • If you have the right to choose Due Diligence (rather than a quick test) you should request a consolidated balance report.
  • Be sure to check the value of financial liabilities. However, please note that the debts revealed during the Business Due Diligence should not be treated as a threat. It all depends on the specific business model and situation.
  • A more factual indicator is the company’s credit rating (if applicable).
  • You should assess the actual debt-to-equity ratio, as without this linkage the actual values are not indicative.
  • The amount of profit generated is more important than the total amount borrowed.
  • If the Business Due Diligence reveals that the financial indicators differ significantly each year, an in-depth Due Diligence is required. In some cases, this fact may point at the financial stagnation and the inability of management to adapt to new business realities.

Stage 6. Stocks value

  • Business Due Diligence implies a mandatory double study of stock prices – in the long term / short term.
  • Be sure to pay attention to the pattern of the stock price fluctuations (volatility, stability).
  • In Business Due Diligence, it is worth correlating the company’s profits and the dynamics of the stock prices.
  • Try to consider all risk factors, no matter how subjective their perception may be.
  • Remember that the results of the legal investigation are meaningful yet not predictive. 
  • Unsatisfactory dynamics may quite enable the business growth in the future, while decent results of the analysis may prompt a gradual decline of profitability.

Stage 7. Company strategy, vision for the future

  • Performance of a Business Due Diligence does not necessarily mean participation in the management of the company in which you are planning to invest. Cooperation in conducting legal Due Diligence is not guaranteed either. Therefore, the need to clarify the plan and the format of the business operation even for a short-term period is a complex objective and more of a predictive rather than evidence-based nature.
  • If it becomes known from reliable sources that an additional issue of shares is planned, the value of each individual share on the exchange will drop.
  • To better envisage the prospects of the company, you can rely on the 2- or 3-year-forecasts made by stock exchange analysts. They are usually rather correct.
  • Try to identify other important factors – the ones not directly related to the company or its business.
  • If the Business Due Diligence reveals the company’s plans for major changes in its organizational structure (mergers, acquisitions), this can also impact the value of the shares.
  • Be sure to monitor all changes in the law. Some amendments and bills can benefit the business, while others can make it significantly less profitable.

Stage 8. Risks

  • Regardless of what Due Diligence methods are used in the Business Due Diligence, risk assessment remains a critically important evaluation tool.
  • It would be impossible to assess all risks with 100% accuracy having a limited set of parameters.
  • Some legal problems that are detected do not always indicate that a company is not promising. A good example is Microsoft, which regularly sues antitrust agencies in many countries.
  • Signs of unsteady management detected in the course of Business Due Diligence are among the most important negative indicators.
  • Never lose your optimism, but it must be based on factual, objective data and judgment.

‘Angel’ Investing in startups

Business Due Diligence is based on standard rules and regulations that can guarantee that the results will reflect the real state of affairs. Yet, it is impossible to achieve 100 percent validity when conducting Business Due Diligence. But the inaccuracy will be quite negligent.

The situation is much more complicated if a startup needs to undergo a comprehensive screening within a short period. The more hurry, the higher is the risk that Business Due Diligence would be more based on assumptions, suppositions, and probabilities than facts.

Our experts’ advice for investors who are interested in startup businesses is:

  • Consider a contingency strategy just in case of an adverse situation. For example, you may make provisions for getting invested money refunded in full (or at least its biggest part).
  • Consider the possibility of sharing risks with other investors. The prospective gains in such a case will be smaller, but the losses will not be as significant.
  • Be sure to keep track of any developments in the business field of the startup. This applies to technology, government policy, legislation, market attitudes, successes/failures of competitors. Be alert if your Business Due Diligence reveals signs indicating that the point of no return on investment is close (as it was with the Dot-com bubble of March 10, 2000).
  • Choose startups that offer truly innovative promising products, services, and technologies. 
  • According to statistics, the conventional term for most investments is 5 years, so choose startups with a higher ROI tied to this period.
  • When ordering Due Diligence for a startup business, remember that the focus should shift from past achievements and success to the company’s growth plans. But do not forget that they must be feasible (doable). Some startups purposely twist their dossier solely to attract investment.

Types of Business Due Diligence

As we have already mentioned, the Business Due Diligence procedure is standardized. The methodology of Business Due Diligence can vary, it all depends on the goals set, the subject of the analysis, available resources, and the required depth (accuracy). There are two Due Diligence options – the hard and the soft ones. This is especially useful when mergers and acquisitions are planned.

Hard type of Business Due Diligence 

  • The hard BDD type is a classic type of Due Diligence.
  • It involves a rigorous legal investigation based on statistical mathematical laws.
  • It gives greater attention to numbers and factual data.
  • Costs, actual M&A benefits, the structure of the acquired company, assets, and existing liabilities need to be studied.
  • This type is also known as Enhanced Due Diligence.

Soft type of Business Due Diligence

  • The soft BDD type is becoming increasingly popular in the 21 century.
  • The subject of special interest is the company’s corporate culture, the management style, and the human factor.
  • There is no emphasis on numbers and facts, though they can be moderately manipulated or overemphasized.
  • Soft Business Due Diligence is now considered more effective since it is extremely difficult to describe the volatile nature of modern economic relations numerically. Statistics show that the reason for more than half of M&A failures is due to the human factor, which is not taken into account in the Hard Due Diligence.

Comprehensive Business Due Diligence 

Most often, the legal investigation of mergers and acquisitions focuses on a few fact-based numerical indicators (even though the effectiveness of the hard DD is less obvious).

The basic EBITDA criteria (Earnings Before Interest, Taxes, Depreciation, and Amortization) for Business Due Diligence are as follows:

  • profit (before deductions)
  • taxes
  • depreciation and amortization
  • wear/aging
  • indebtedness (accounts payable, accounts receivable)
  • movements in the company’s accounts
  • capital expenses.

Please note: if you are interested in the field of technology and manufacturing, the DD focus will shift to the criteria of intellectual property and physical capital 

Additional Business Due Diligence  options

  • review and audit of financial statements
  • forecast of short term revenues
  • analysis of the sales market (consumer, corporate)
  • elimination of operating redundancies 
  • potential risks of litigation
  • the impact of antitrust laws on a company/startup’s business
  • relationships with subcontractors, suppliers, key partners.

Please note that you can expect the best results from Business Due Diligence only if you apply (and correctly interpret) both the hard and the soft BDD options 

Effective investments under current economic conditions are quite feasible, and there can be quite a lot of promising options for you. 

The same can be said about businesses: you can choose from a multitude of offers your ‘right’ company registered in the ‘right’ legal form in the ‘right’ jurisdiction, with the ‘right’ bank account, with the ‘right’ ownership structure. The word ‘right’ means here ‘the one that matches your specific goals and objectives’.

We are ready to help you with your ‘right’ choice, all organizational matters and arrangements, and offer you the best solutions for asset protection and diversification. If you are interested in this proposal, please contact the InternationalWealth experts by writing to the e-mail address given at the top of this page.

You are welcome to find on our portal more information on how Business Due Diligence can help your investment and decisions. Here are some of the recent publications:

We are always open to new ideas and consider our team’s impeccable reputation our main achievement. Stay with us, there will be many more interesting things to discover!

I need an account in a foreign bank. Do I have to prove my compliance?

Yes, compliance is a standard requirement set by any financial institution in onshore and midshore jurisdictions, and often even in offshore countries. Unfortunately, the times when banks would welcome any client are long gone. Now the clients have to prove their worthiness to the financial institution. Here are examples of some aspects that may alarm bankers and complicate your efforts to open an account: 1) when there is no clear indication of the tax residency of the potential client; 2) if the client cannot submit a documented proof of the legitimacy of the source of funds; 3) in case the bank has not received the requested additional information (besides the standard list); 4) when the company ownership structure is complicated and needs explanations; 5) if the beneficial owner(s) come(s) from sanctioned countries (black- or greylisted). You are welcome to find on our portal many detailed articles on how to deal with banks and open bank accounts.

Are the notions of ‘compliance’ and ‘compliance control’ synonymous?

Formally, these are different concepts, although consumers often think they mean the same. Compliance means the fact of complying with some (usually legal) requirements. The main areas where compliance is in the focus (not tied to investments, mergers, and acquisitions) are as follows: 1) anti-corruption measures; 2) effective data protection; 3) Labor law; 4) control over export operations; 5) the principles of fair and open competition; 6) environmental and health protection; 7) information security; 8) product quality control and its safety for consumers. Compliance Control is an action, it involves the following activities: 1) audit (internal, third-party); 2) general safety control procedures; 3) preparation of reports and documents as part of some inspection; 4) policies and methods to ensure compliance.

How can I raise funds for startups?

This is an interesting question, the answer to which can be both simple and complex. It very much depends on the jurisdiction and its provisions, the uniqueness/innovation of the concept, the status of competitors (if any), and the intentions of the startup founders to scale up/upgrade the project. Usually, investors require the following information about the startup: 1) a detailed description of the product (or service); 2) your motives for starting this particular business; 3) your personal opinion of how your product compares to competitors’ offers; 4) your subjective opinion on the prospects of your business; 5) the ROI potential for a potential investor; 6) the guarantees of the risk-proof safety.

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