The Need to 'Look Before You Leap' Ahead of Corporate Investment or M&A

Shannon Green

Corporate Counsel

11-02-2012

Lured by lower costs, new customers, and an untapped labor pool, many businesses are increasing their presence in emerging markets. But as companies step up so-called "greenfield investments" and M&A activity in these markets, many executives are worried about escalating compliance and integrity-related risks. 

Seventy percent of respondents to the fifth annual Deloitte Financial Advisory Services "Look Before You Leap" survey said they are "extremely" or "very" concerned about those risks when their companies conduct business in emerging markets. Seventy-one percent said the risks have gone up during the last two years.

Wendy Schmidt, global service line leader of business intelligence services for Deloitte FAS, says she expected those numbers to be high. But she was somewhat surprised by the level of confidence executives expressed in their companies' ability to identify and mitigate compliance and integrity-related risks in emerging markets.

"Last year, they were much more confident," says Schmidt.

Just 38 percent said they're "extremely" or "very" confident in those processes when it comes to M&A transactions. Even fewer, 34 percent, expressed the same level of confidence regarding the somewhat riskier category, greenfield investments. Those investments typically involve starting a new venture in a foreign country by constructing new operational facilities from the ground up.

In engaging new third-party agents and vendors, respondents expressed similarly low levels of assuredness. Major companies often work with thousands of third parties —vendors who manufacture products, as well as agents and distributors who help sell and deliver products and services to customers. Forty percent said they were "extremely" or "very" confident in controls when doing business with vendors and 36 percent felt similarly secure when engaging agents.

The survey was conducted during a two-week period in May of this year. The survey's 126 respondents represented a cross-section of industries, including financial services (29 percent) and manufacturing (25 percent). Seventy-one percent of respondents came from companies headquartered in the United States, with Europe, Asia, and Canada accounting for less than 10 percent each. The individuals responding to the survey included C-suite executives and VPs, as well as directors, department heads, and managers.

The survey's title speaks for itself when it comes to the risks of doing business in emerging markets—nations undergoing rapid industrialization and economic growth. "It's important to understand who you're doing business with before you enter a relationship," says Schmidt. But for her clients, knowing who they're doing business with can be much more challenging in new and unfamiliar regions.

The top obstacles survey respondents said their companies face in identifying and mitigating risks are inadequate staffing or budget, lack of required skills and knowledge among company employees, sufficient due diligence, verifying information, and lack of senior management commitment.

Bribery topped the list of business leaders' concerns with doing business in emerging markets around the world. Forty percent of respondents named bribery of government officials as the primary risk. Commercial bribery or kickbacks was another top area of concern.

More than 70 percent of respondents said their companies conduct due diligence prior to making M&A transactions or greenfield investments. But despite these bribery concerns, only half of respondents said their companies conduct extensive due diligence on the issue. 

Less than half of respondents said their companies always or almost always conduct due diligence when engaging in third-party relationships. Third-party agents have been of particular interest to the U.S. Department of Justice when it comes to Foreign Corrupt Practices Act enforcement actions, says Schmidt. "That's really where companies need to focus their due diligence," she says. 

Despite the risks, respondents predict their companies will continue to take advantage of opportunities in emerging markets in the near future.

Forty-one percent of respondents said their companies are "extremely" or "very" likely to complete an M&A deal in an emerging market in the next two years. The number jumps to 56 percent for companies with at least $1 billion in annual revenue. Twenty-eight percent said their companies are likely to make a greenfield investment; 44 percent of respondents from companies with at least $1 billion in revenue said the same.

Schmidt says some key takeaways from the survey are the need for conducting adequate due diligence and for increasing the involvement levels of senior managers and boards. Where there's a focused "tone from the top" during such deals, she says, confidence in the protocols used to identify and mitigate risks will spread throughout the company.