Due diligence in an Indian context - what to watch out for ?

Before I begin, I must say I have been quite happy with the response I have been getting on the blog from the handful of people who have been following it. There has been overwhelming criticism that I am painting a gloomy picture of PE in India and so, here goes some effort towards me cheering this up.


The Due diligence (did I hear someone say "Ouch ! that is so boring - we are already convinced about the business case. That is best left to a big 4 firm to submit a report") is one of the most overlooked aspects of deal making, especially in India where entanglements (into other businesses, either of the promoter or his close members/confidantes) are a big hurdle to deal with apart from the usual E's - Egos, Emotions and Expectations (Courtesy : Venkat of Veda Corporate Advisors, arguably one of the respected names in the mid-market deal making space in India)

For most of us, Due Diligence is a drab process where you are focussed on vetting the internal processes and financials of the company to see if they stand up to the image they have been projecting thus far. However, there are a few softer aspects that go beyond the ambit of what an external DD specialist is capable of (which have been learnt the hard way). So here goes :





Promoter:

• Commitment :Will his/her mind be fully into this business post the transaction ? If not, whose eyes are we going to be looking at ?
• Ambition :Is the promoter ambitious and willing to pull out all stops to make this a success ? This, to go by anecdotal evidence, it seems is the singular reason why some investments go the entire distance and most fall by the wayside.
  
• Professionalism :Are there any familial pulls/strings that one needs to be aware of ? For eg., feuding brothers, an acrimonious marriage with a wife who is also a business partner? Does he realize that he has to forgo a lot of his intertwining to scale this up ?
  
• Openness to ideas:A lot of promoters having been used to a dictatorial (and that is not necessarily bad in a small, growing company)
  
• Hunger for value creation: While one might think ambition should be intertwined with hunger for value creation, a small sect of promoters do not realize that there are other stakeholders - investors, employees, management who also have to reap the rewards of all the hard work that went in. There are a business groups which seem to live by the credo " Upside is all mine, downside is all the investor's".
  
• Focus & Predictability of behaviour: A lot of entrepreneurs who I have personally worked with seem to get distracted after a while (either because they are bored or get turned on by other business opportunities). In their quest for experimenting with the new, they get into risky moves - diversification, punting big, pursuit of self-glory etc.. For investors though, these are strict "no-nos"
  

Organization

• Competence:Is the rest of the organization upto scratch in terms of delivering the results envisaged for the company ? Or has the promoter surrounded himself with sycophants whose field of vision is limited to doing the best that their boss wants them to do.
• Financial checks and balances: How strong is the CFO ? Can he act as a check and balance on strategic issues - can he put the company ahead of the promoter should the situation arise ? Can he veto an unrelated diversification ? A large number of companies in India still have CFOs who are at best rubber stamps resulting in disastrous situations post the investment
• Vision and aspirations of the second line: Are the second line of management also seeing an upside in their own careers ? Or are they looking at this round of funding as one that facilitates a cushier lifestyle?
  

The above I guess is pretty much commonsense for someone who has been in this business for long. But, exactly how does one answer the above ? The simple answer is in "freeing one's mind' - Use your network to tap into market feedback from customers, vendors, peers, friends of promoter, ex-employees. I have personally found a lot of useful insights about the promoter by talking to customers, ex-employees and vendors (who are the only ones who have the benefit of "inside out" and "outside in' knowledge" - a rare but useful combination to asses a person/organization). They are the best ones to answer the following questions:

• Behaviour: How has this promoter been in the past ? Has past success changed him ? Is he committed to his employees ?
• Values:How strong are his value systems ? Does he live by scruples ? Is he keeping his customers happy ?
• Perceptiveness: Is he perceptive to market feedback ? Is he aware of changing market dynamics and actioning on them ahead of times ?
  
• Capability/competence :Do employees/vendors look upto him ? Do they think he is amongst the best there is in the industry ?

As always, happy to take any feedback. Do mail me or post your comment on the blog.

~Varadha
(varadha.r1@gmail.com)
+91-9940670064