Due Diligence
----The Indispensable Weapon in Business of 21 Century

This article gives an overall explanation of the meaningfulness and contents of due diligence and illustrates the decisive role it plays in business activities with true examples. Then it is showed that the prospect of credit industry in Chinese mainland is bright, which is the main point of this article, with a description of the actual situation of credit services there and the trend of international economic development.

Current society is, in reality, a society of credit. Credit is the basis of company's or individual commercial activities. Anyway, how can you know about the credit of trade partners in joint venture and cooperation, or of financing and investment targets? The whole transition process is filled with such questions. That is to say, you must face these potential risks every moment. So understanding the credit situation of opposite side is becoming an urgent requirement for enterprise to avoid losses related to business frauds.

Firstly, we will talk about the definition of credit investigation and due diligence. Credit, in economics, appeared with the social evolution from barter economy to credit economy. It can be explained as the credit-debt relation resulting from the present ownership transfer aimed at future pay back, and based upon the confidence held by the creditor toward the pay back ability of the debtor. There are narrow and broad understandings of credit investigation. The former means just the investigation or confirmation of others' credit standing. The latter includes also gaining others' confidence toward himself. In other words, narrow credit investigation targets people other than investigator, named external credit investigation; broad credit investigation targets itself, too, and named internal credit investigation. Beijing Steele Business Investigation Center (abbreviated as "Steele" below) is such a professional service of credit investigation. It provides a strong support for risk avoidance for its customers by its widely undertaken investigation to prevent business-related frauds, investigation on credit before and after lawsuit, pre-employment investigation about background. The credit investigation is discussed in this article with its narrow meaning, that is, external credit investigation.

Credit investigation is an important part in modern business management. The coming 21st century means the coming of a promising and challenging new era for the global economy. With the technology progress and social development, the environment and the techniques of doing business home and abroad are changing continuously, and the whole world is becoming gradually a global common market. Frequent international business, as well as the intensive competition, stimulates the growth of business frauds. It is necessary to control the credit risks in trade characterized by complexity and uncertainty, for the business field is just like a battle ground, and you can fight a hundred battles with no danger or defeat by knowing the enemy and knowing yourself.

The credit investigation is also a basic task. Whatever successful merchant with whatever trade experiences can't avoid completely risks by his own power. Investigation and research are needed to deepen the understanding of anything. Before you decide to do business with a customer, all of the recent information about your trade partners provided by a thorough credit investigation conducted by a professional credit service can enable you to make good decisions, as if being personally on the scene. It helps not to miss each chance of gaining and to avoid each possible loss from illegal activities. It is the same thing with getting a new friend. Try to know his personality, diploma, expertise, attitude to deal with others, moral norms, family situation, etc. There is a good example in Steele. In June 2000, one group wanted to co-develop one programs with one of two Nanjing real estate companies but it was lack of information about them. On commission, Steele sent investigators to Nanjing to take overall investigation. One week later, the credit situation about them was getting clear, a comprehensive report was done. Through analyzing, studying and comparing, the client got a clear idea about the credit situation of these companies, and knew well to whom to cooperate with.

Credit Investigation enables us to understand the true face of investment targets (investment environment included) and cooperation partners, which serve as basis of judging their credit situation and deciding if giving credit to or cooperating with them.

During the whole trade process, the investigation on credit before trade activities is undoubtedly important. Still, the investigation on credit during and after the trade is necessary, for credit risks still exist at that period, such as the closing, fraud, bankruptcy because of poor management or other financial losses. So the newest credit situation of the other side can be learned so as to reduce or avoid credit risks. Only in this way, strategies can be designed within a command tent, and a success can be ensured.

Due diligence should cover all sides of investigated company. Generally speaking, following items should be included in it:

A. Basic situation of the enterprise. Such information as name, address, telephone number, fax, postal code, nature, business field and number of employees of the enterprise provides a general understanding of it. Different credit policies can be applied to companies of different nature. For example, exclusive ownership ventures and stock firms should be treated differently. The former is established by one's own investment, correspondingly the capital and debt of company is just those of investor himself. If the company capital is not enough for repay the debt, investor should compensate the difference with his own assets, which safeguards the rights of creditors. On the other hand, this type of companies is often of small scale, having a weak financial power and can't endure strong changes, so prudence is needed when doing business with them. As for stock firms, special conditions on capital and profit are required at the time of their establishment, therefore, probability of getting into bad account is relatively small.

B. Historic backgrounds, including date of establishment, bureau of registration, registered capital and initial number of employees, historic evolution, stockholders/stocks, superior administration.

A judgement can be formed with the above data about the legitimacy of the enterprise, that is, if the enterprise was founded legally or illegally. In addition, business scale can be estimated with the amount of registered capital. The historic evolution reflects the company's operation and changes in the past years. If there are changes of stockholders and business scope, reasons of such changes should be studied. Meanwhile, the age of the enterprise can be also used as one criteria of its operation ability. If one company has a long history of operation, then it can be considered possessing rich experiences, high management ability, stable supply and sales channels, and it is relatively safe to do business with it. Another important clue is the background of stockholders (including general situation, personal CV, etc) and their shares. More shares are held by a specific stockholder, more control power he owns. Especially for small and middle size companies, big stockholder is often the manager of company, and a good understanding of him is particularly important. There is another point to notice. Are the main stockholders also investing in other companies, how about their operation? Running into debt or bankruptcy of these companies, particularly for exclusive ownership ventures or business in partnership whose stockholders hold unlimited liability, will endanger the operation of the company in question. Besides, information about the knowledge, experience and health situation of stockholders can also be obtained. Seeming simple, these data play a decisive role in company's business and development. Stockholders make decisions about company mission and development strategies and command all business of company. It is not hard to see that a successful manager should be learned, experienced, honest, keeping promise, able to manger and lead, and having broad social associations. Steele once accepted such a case. One company in southern region in China got to know one businessman via personal relationship, signed a trade contract with him without conducting credit investigation, and sent goods to him. But the latter, after getting the goods, refused to pay in various excuses, which caused a loss of as much as one million yuans. Afterwards, this company entrusted Steele to investigate the businessman and his company. It was found out that this businessman had a poor reputation in local area and beard much debt. It is obvious that investigation beforehand should have avoided the serious losses of this company.

C. Executives, including the name of company's highest power institution, legal person, chairman, president, vice-president, their education background, professional experiences, and organizational structure.

The steady development of a company depends upon the healthy and sound organization, the stale personnel, intelligent and capable leaders. The frequent reconstruction of organization and changes of leaders are signs of personnel chaos and vacillation in policy. Doing business with such a company requires a close surveillance of its situation as reference.

D. Financial situation, including balance sheet, table of profit and loss, and financial ratios analysis. Financial analysis can provide important information about credit. It can be used to forecast the potential credit risks. The situation about a company's profit and loss is illustrated by the table of profit and loss, one of the most important signs of company's success or failure. The balance sheet reflects the capital management and financing structure of company. The distribution of different types of capital is reasonable or not, how about the propitiation of debt and equity, and what is like the assortment of debts (long-term or short-term, bank debts or accounts payable). An overall estimation of company's ability to pay back when the accounts receivable expire can be based upon the analysis as above. The financial ratios analysis means using the ratios of different items in financial reports to evaluate the financial situation of company. These ratios, such as ratio of profit on investment, ratio of profit on sales, average receiving cycle, are used to measure the efficiency of management and the degree of the effectiveness of company's ability to manage accounts receivable.

E. Bank accounts, including the opening bank and account number. According to rules, the capital account of a certain company has uniquely one opening bank and one account number. Another account and account number of foreign currency is added to exporting and importing companies.

F. Management situation of the enterprise, including main and around business, main products and their production, purchase of raw materials, selling areas of products, payment of purchase and selling, business reputation, names and telephone number of principle suppliers, personnel situation, environment and surface. The information as above reflects the nature of business company is running and the diversity of its business; whether the company has stable supply sources; the distribution of product or service is regional, national or international; where the office is located and how about the condition; how about the degree of pressure of employees?. All of that reflects well the company's management level and situation.

G. Overall evaluation, namely, the analysis and suggestions provided by analyst. Based upon the accurate investigation report, the credit institution presents their opinions and suggestions about the credit situation of the company in question with their own rich experiences.

All of above is about the contents of due diligence based upon the principle of truth seeking. The true, fair and objective investigation is the objectives sought by Steele. The services about credit investigation appeared with the social and economic development and evolved with the actual requirement. To avoid and reduce the appearance of credit risks is the original motivation that initiated due diligence. Today, the buyer market dominates the economy, and credit investigation will surely show its advantages.

Credit services are dated long time ago in some developed countries and an independent industry has been formed. However, still in a stage of formulating in mainland China, it can't be called an industry. In the United States, the credit services hold more than 2/5 in the consulting industry. In Hong Kong, there are more than 50 companies engaged in credit services. By contrast, in mainland, it appeared only in early 90s. According to statistics of Department of Foreign Trade and Cooperation, during 1985-1990, the exporting companies in mainland accumulated a total accounts receivable loss of as much as 6.8 billion dollars. And 2/3 resulted from not taking a credit investigation about the other part before the transition. Therefore, the Department signed a document to stress the importance of undertaking credit investigation before transaction and a special training institution was founded for that purpose. Bureaus of all levels of foreign trade are beginning to organize regularly training about credit management for some state-owned foreign trade companies. Credit investigation is added into the new-issued textbooks of international trade. Members of some international investigation associations are stepping into mainland one by one, and a rapid development is seen these recent years. At present, just in Beijing, there exist more than 10 companies engaged in credit investigation. Steele is one of them, and moreover, it is the only member in mainland of 8 international investigation associations.