Margarita Karpenko’s career in due diligence is almost as old as independent Ukraine. She got her start in consulting businesses in 1992 and has built up over two decades of experience in mergers and acquisitions. Today she is a managing partner at DLA Piper in Kyiv.
And while technologies and the Ukrainian economy have changed over those years, she believes “the traditional approach to acquisition stays the same.” In other words, “before buying, you need to study it. And you should study it in different ways, which is done through due diligence procedures.”
Due diligence digs deep into the target company’s commercial, legal, financial, environmental and technical background. And because it’s never fully complete — there’s no such thing as perfect due diligence — the parties involved must strike a balance between what they need to know and knowledge for its own sake.
And given some of the corruption schemes in certain Ukrainian businesses, a little due diligence can go a long way in Ukraine. It has its national peculiarities, too.
Due diligence in Ukraine “is not limited by the legal issues, and includes lots of non-legal, but rather investigative issues besides only analyzing the provided documents … you also want to include such sources of information as internet, telephone calls, talks with people, investigators going to the sites,” explains Max Lebedev, a partner at GOLAW firm.
A costly undertaking
But it isn’t easy or cheap. Specialist knowledge and technical skills are needed. A high tolerance for stress helps. The atmosphere can be toxic.
“Working in the deal environment can be stressful, because you are constantly working on very tight deadlines. And those deadlines are quite often indelible, because the parties may have agreed to a limited period of exclusivity to conduct the due diligence and negotiate the deal,” says Peter Latos, a partner at KPMG Ukraine.
It is also costly. Igor Sotnik, an investment banking director at Concorde Capital, estimates that the price tag for such projects ranges from $60,000 to $100,000 for legal, financial, and tax due diligence combined.
The amount differs “depending on the volumes of business and the scope of the analysis, as the scope of analysis is set for each particular due diligence: one or two previous years, the depth of indicators,” he says.
Most recently, Sotnik has been involved with Concorde Capital’s acquisition of Ukrainian assets belonging to the German HeidelbergCement Group. The investment fund purchased the assets for itself on May 17. Prior to that, Concorde conducted financial due diligence on its own as “we had audit reports and there was some comfort with the financial indicators,” Sotnik says.
“We were primarily interested in the financial model of that business and we involved (a specialized law firm) for legal due diligence to check the legal aspects: court cases, property rights for major assets and so on,” he tells the Kyiv Post.
He says the due diligence confirmed Concorde’s understanding of the company. But there were other benefits too. “It is also important to understand the details that do not influence the pricing but call for attention in the future,” Sotnik says.
Concorde Capital declined to disclose the value of the deal with HeidelbergCement Group. The German industrial group also declined to comment on the sale of its Ukrainian business. According to its website, HeidelbergCement has sold cement plants in Italy, as well as stakes in similar businesses in Canada, Morocco, and Syria.
Lengthy research
A quick due diligence procedure lasts a month. More tedious ones take from two to three months to complete. Still, the process “is structured in a sufficiently consistent manner,” says Andriy Nosok, managing director for private equity at the Dragon Capital investment bank. “In the first stage, a provider of due diligence services — one of Big Four (audit firms), for example — sends a list of questions, for which the target company… has to prepare documents or answers.”
Next, the firm planning on making the acquisition evaluates the answers and can ask additional questions. Drafting a due diligence report begins when all the questions have been clarified. The report is then submitted to the prospective buyer, who can assess the risks of the target company.
In exceptional cases the due diligence process lasts much longer, if a business conglomerate stands up for grabs.
Lebedev remembers assisting in acquisition of a holding including 15 separate companies and “each of them had its own history, its operations, its problems. So, we spent about a year to make the due diligence of that group and resolve the outstanding issues for preparing the business for acquisition.”
Deal makers & breakers
The findings can, of course, kill deals if “risks are revealed, which fundamentally change our understanding of the business case,” says Nosok. “For example, we have initially been presented with one set of financial results and business dynamics, but after having a look at them with the auditors we understand that it is totally different.”
There are other red flags signaling it is time to halt acquisition negotiations: “Firstly, this occurs when you spot criminal cases… connected with the company, its executives,” says Lebedev. Such cases can concern “either fraudulent actions, or very often tax offenses.” Even if such tax offences were cleared, there is little guarantee in Ukraine that it was cleared for good.
Another typical red flag arises if the company under analysis is connected to a politically exposed person. “Here the majority of profitable companies have such kind of connection. In this case corruption-related risks can arise much later,” Lebedev says.
“If you buy a company from such a person and later an anticorruption agency starts investigation on such a person, this company will be later on involved in the case too. Accounts, property of the company will be frozen,” Lebedev predicts.
But, if no “deal breaker” is found, transactions usually go through, with perhaps modifications in price and conditions.
“The specific risks discovered during due diligence are reflected in the transactional documents in the form of warranties by the seller,” Nosok says, adding that “the third scenario is incorporating the risks into the price.”
An example of a warranty by a seller can be an agreement to take part in court proceedings on the buyer’s side if an ownership title for a certain asset is disputed in court.
Walk your talk
Sometimes consulting businesses merge with other companies. This was the case with EBS consulting company, which acquired Intercomp Ukraine, an accountancy firm, in July this year. Olena Volska, EBS managing partner, provides due diligence services to her clients and did not skip due diligence while on shopping herself.
“Our company’s principle is ‘walk the talk,’ so we do what we recommend our clients to do. Naturally, we could not but do the due diligence,” explains Volska.
For Nosok it is also unimaginable to avoid due diligence in an acquisition: “as professional investors we cannot abstain from holding due diligence” and adds that “due diligence is one of must-have procedures, which we do on obligatory basis.”
For Dragon Capital, Nosok’s company, the leeway consists of “scope of due diligence, the spheres of analysis; here we apply our professional judgment for understanding how much we need commercial due diligence, for example, or if we can do it on our own.”
Follow the rules
When the due diligence process starts, there is simple advice to follow for both sides of the deal.
“For sellers, in this process it is most important to have reliable information from the very start,” Nosok says. After all, a failed agreement due to sloppy due diligence incurs expenses for both parties and can even lead to legal consequences.
For investors, it is essential to “always follow the professional procedure for evaluating companies,” Nosok advises. He suggests putting emotions aside and “completing the list of things (necessary) for seeing the general picture and making a balanced decision.”
But, in Ukraine, following the procedures can be the biggest challenge.
“Sometimes the difficulty comes from the seller’s lack of experience,” says Karpenko. “Especially if it’s Ukrainian sellers, who don’t know about the techniques for making a deal.”
