ABC due diligence is traditionally thought of as fulfilling a compliance requirement. However, such diligence can also be used to preserve existing value and potentially create value as well.
For example, a targeted diligence exercise can identify weaknesses in a target’s internal processes. Remedial action may then be taken to prevent ABC risks from materializing, and thereby extracting value from the investment. This preserves value. The cost of the remedial action can be factored into the purchase price. If the weaknesses cannot be remedied, the purchase price can be reduced correspondingly so as to reflect the additional risk that the acquirer will be taking on.
In cases where the acquirer has significantly more bargaining power, the purchase price or part thereof may be paid into an escrow account (instead of being immediately paid to the vendor on the completion date). Post-completion, if lapses or weaknesses in internal controls are identified, such amounts may be deducted from the escrow account and returned to the acquirer.
Less apparent is the advantage that the target’s internal processes may be brought in line with exacting international best practices (and not just domestic standards) using the findings of ABC due diligence. This, in turn, has a positive positioning effect in relation to potential co-investors, private equity investors, sovereign wealth funds and other parties which may be subject to more rigorous ABC compliance requirements (e.g. those imposed by US and UK legislation). To elaborate, such other parties may view the target as a more favourable:
- joint venture partner;
- supplier / distributor / other contractual counterparty; and
- acquisition target (if an exit is eventually desired).
This, in turn, creates value by improving the target’s revenue generation potential. In the event an exit is desired, the pool of potential acquirers is also expanded beyond those comfortable with domestic standards (which may lag behind international best practices), and this accordingly means that a higher price may potentially be negotiated for and obtained.