The BRIC rise and the subsequent effect on Due Diligence
by Ari Lee
The discussion surrounding BRIC – the acronym used to describe the nations of Brazil, Russia, India and China – has changed dramatically over the course of this century. The start of the 2000’s marked the first use of the term, and signaled a shift of influence away from G7 nations towards the developing world; in the early stages discussions included BRIC nations’ rapid GDP growth, their wealth of natural resources, their growing trade discrepancies with the developed world or the loss of jobs by the developed world to BRIC nations due to outsourcing. The middle of the decade featured a release (and subsequent follow ups) of a report by Goldman Sachs speculating that BRIC countries would become the most important nations in the global economy by 2050. The Global Financial Crisis starting in 2007 only accelerated this prediction; although not completely unscathed, BRIC nations not only withstood the crisis but grew their economies and strengthened their positions as major consumer markets, largely due to growing domestic demand and large foreign exchange reserves.
The BRIC nations’ rise to prominence as major players within the global economy and consumer markets is correspondingly reflected in their importance to M&A practitioners and multi-national corporations; this is also reflected in the increasing deal-flow in BRICs when compared to the global economy.
What is interesting to note is that while there has been a dramatic shift from inbound investment into BRIC nations to outbound investment from BRIC nations, the level of domestic activity still outnumbers deals involving a BRIC nation and a non-BRIC nation by at least 3:1. This has had a profound effect on M&A practitioners from developed countries completing transactions involving the BRIC regions as the modus operandi of executing a deal, namely the due diligence process, differs from those transactions involving only developed nations. Since the majority of the deals in BRIC nations are still done domestically - many of which are simply mandated by the governments - the due diligence process (document preparedness, document availability, willingness to adopt modern technologies, etc.) have been slow to adapt to global standards.
In a report commissioned by Merrill DataSite in July of 2011 surveying 150 corporate executives, 73% said the due diligence process was slightly difficult to very difficult, with only 27% reporting no problems. Culturally speaking, due diligence in BRIC nations, and most developing nations for that matter, is widely viewed with disdain. Many of the companies are family-owned or have large majority shareholders who historically have been unwilling to show their books (and the associated “dirty laundry”) to outside parties. There is also an inclination towards entering into a specific period of exclusivity with one potential partner rather than conduct a full auction process, which again limits the scope of activities. Lastly, personal relationships play a larger role in BRIC nations and thus activities such as face-to-face management meetings hold higher significance than they would in the developed world.
The due diligence process in BRIC nations is also affected by what can be termed as structural or procedural reasons. As many of the governing institutions have only recently adopted global standards, corporate governance is still in the nascent stage. As a result, many of the documents, information or corporate controls that investors would typically like to examine either exist in company specific formats or don’t exist at all.
Acceptance of these limitations as the cost of doing business in attractive markets by investors is dwindling due to changing capital conditions, investors are demanding more transparency. Companies within the BRIC nations have brought further scrutiny on themselves with their own actions; not only does Transparency International rate BRIC nations as some of the lowest ranked countries with regards to corruption, a number made even worse when the size of economy is taken into consideration, but publicly embarrassing corporate scandals have become commonplace in the news.
As a result, there is a trend towards modernization and formalization of corporate governance and the due diligence processes; this is not only being driven by global investors, but also domestic BRIC companies. Virtual Data Rooms (VDRs), are online platforms created to manage and control the due diligence process. This technology is standard practice in the U.S. and Europe but has only recently been adopted by corporate finance professionals in BRIC and other developing nations. Internal studies show that not only is the adoption rate of VDRs increasing, even for domestic BRIC deals, but the length and size of projects is increasing. Hence, more documents are being reviewed and scrutinized before making investment decisions. Investors are demanding VDR usage to compensate for the increased depth and scope of the due diligence process. Firms sharing documents are turning to VDRs as a way to facilitate a more extensive process while still maintaining security and control of their private company information.
This is an excerpt from Financier Worldwide's Global Reference Guide: Mergers & Acquisitions 2011. To download the complete guide, click here >>
