Adventures in Due Diligence in Russia
Vladimir Malenko
Climate investment and Islamic finance expert; Islamic Finance News Contributor; Islamic ETF strategist; Aviation Aficionado
Hardly anyone would argue that good and thorough due diligence is one of the keys of successful private equity investment. The goal of the DD is to weed out companies that employ questionable practices.
Here I would like to describe 2 of the most common “questionable” practices found among Russian target companies:
1) Some of the company’s suppliers may be owned by the company’s top managers. Sometimes the suppliers are set up anew, but there are cases when the top managers of the DD-ed company “persuade” the shareholders’ of a supplier to “voluntarily” provide a share grant in exchange for “productive long-term relationship” with the target. Such suppliers are less concerned about competitive pricing, payment terms and delivery conditions. In any case, the company is getting a bad deal, although the top management of the target is handsomely rewarded.
In some extreme cases the target may have a mega-supplier (of course, controlled by the top management), which limits access of other suppliers to the company. The access is granted in exchange for cash, shares and other modest consideration.
2) Some of the company’s suppliers may be owned by the local authorities, regulators, and/or politicians. The direct ownership and control is rare, but here is one curious fact about Russia – although most of the Russian authorities are noble, honest and poorly paid, their wives, brothers, and children tend to be fantastically successful in business, and thus can easily support their poor relatives-in-government. Such suppliers count on support from the “higher powers” to win business from the target company.
Thus, the former mayor of Moscow was slaving for years to develop the city, working long hours for miserable wages. But as he was elected the mayor, his wife had discovered some tremendous entrepreneurship talents and quickly became a billionaire and the richest woman in Russia.
When faced with a supplier situation similar to the described above, it is better to walk away from the deal. Unless you are looking for some pain in the A**
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8 年Valdimir, good article exemplifying a key aspect of due diligence. It's not just about the numbers and financial analysis, but it transcends to the cultural, social, and unstated established business practices. Back-room deals, corruption, and favoritism is a de facto practice around the world. More obvious in 3rd world countries and emerging economies (BRIC), and more subtle in 1st world western nations yet there .. (want a high political post contribute to Hillary Clinton's campaign or foundation). Another interesting aspect of Russian companies (found even in Banks) which can severely affect projections made by a foreign PE firm, is the question of staff salary. When doing a strict financial analysis one will see that a person may have an official $50,000 Rubles salary. that is what is paid to their "Card" (most employees are given a debit type card to which their salary is deposited), yet there is an additional component of the salary which is the "Envelope", this makes up the difference from what would be an almost minimum wage salary to a more competitive salary. Yet this portion is unreported which is a benefit to the firm. So let's say $80,000 Rubles ... the issue here is many times this Envelope is not paid on a timely basis, sometimes for months and months at a time. So there could be a huge liability to the PE firm acquiring a Russian company, or a series of lawsuits for unpaid salary and damages. Specially if a firm withholds salaries on purpose for a quarter to present a different view of cash flows to a due diligence analyst pre-sale. Just like trying to break an under the table vendor agreement, trying to renegotiate salaries after a purchase when the PE firm realizes the payroll is in effect 2 - 3 types more than budgeted can have a major impact to the operation and success. In conclusion one would understand the value of having a local consultant that understands the political, social, cultural, and business practice landscape to anticipate all these subtleties ... the acquiring PE firm could potentially leverage them during a negotiation as a back-pocket surprise giving the PE firm an upper hand.