Several years ago, a device company in Connecticut contacted me and requested that I visit their offices to discuss an urgent issue they were having in China. On arrival, the executive started by telling me his company had recently bought a Chinese device component manufacturer, but that the general manager of the company was no longer answering his calls or emails. He could not explain why.
I asked the executive for more details about the acquisition. He informed me that a year prior they had purchased the Chinese component company because there were only two companies in the world that could make the component at the specs they required. Hence, they paid $20 million to purchase the Chinese company. The company was also paying the general manager at the newly acquired company about $400,000 annually. When I asked the medtech company executive why they had not paid the $20 million over time in installments instead of all upfront, he could not come up with a good answer.
I further probed about how the Chinese general manager had started his company. It turns out he worked at the other company (also based in China) that could manufacture the American company’s component. One night their current general manager unbolted the equipment from the first Chinese company he was working at, put the machines on a flatbed truck, and stole the equipment. The general manager then traveled 300 miles southwest and set up his own operation. The medtech general manager also took five to six key executives with him to his new factory. From there he hired many of his friends and relatives to work at the new factory, so his power and control was very high.
I asked why anyone would buy a company from such a crooked GM and advised the executive to alert his CEO about this problem. Shaking his head “no”, he escorted me to the door. Obviously, this executive did not want the CEO to know what a serious mistake he had made, thus jeopardizing his job.
While it may sound this executive was careless or naive and that this was a one-off event, I can tell you that after 28 years in the industry this kind of blunder is not as unusual as you may think in China and other countries in Asia. I have seen plenty of acquisition horror stories in the Asian markets over the years.
Western companies need to understand that making an acquisition in China and Asia is a risky proposition. Acquisitions in Asia are not like buying companies in Texas where the financial books can be audited, legal agreements actually mean something, and the number of post-acquisition problems can be minimized.
Anytime you make an acquisition in Asia, conduct as much due diligence as possible. Some companies will hire large consulting firms or large law firms that oftentimes send inexperienced individuals to kick the tires and do their due diligence. While this may provide an initial level of due diligence, it is not nearly enough.
For example, in one of my company’s due diligence projects, we acted like executive recruiters and called current and recently departed employees of the target company. After fabricating some false jobs, we would ask the candidates about their current or ex-employer to get insight into the company. You would be amazed by how much new information was learned. While this recruiting exercise may seem to be an “insincere” act of due diligence, this type of extensive work is crucial to getting the full picture of the target in the Asian countries. We also checked out the competitors outlined in the offering memorandum and found them to be a lot stronger than they were initially projected to be.
The bottom line is that you can never do enough due diligence in Asia. It is best to put in the time and effort to fully understand your acquisition target beforehand and minimize unpleasant surprises later down the road.