Rigorous due diligence is life blood of investment: Expert

Updated: 2010-11-22 14:26
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CHICAGO - A US business expert said on Saturday that Chinese companies interested in investing in overseas markets should pay more attention to rigorous due diligence and peer review which are key factors for private investment to succeed.

Richard Wottrich is Senior Managing Director in charge of international desk at The McLean Group, an investment bank providing mergers and acquisitions, capital formation, market intelligence, business valuation, litigation support and exit planning services to middle market businesses.

During recent years, Chinese private funds are growing and looking into overseas market including the United States. When asked about his advice to Chinese private investors, Wottrich told Xinhua News Agency in an exclusive interview: "Professional due diligence and access to all relevant information are the life blood of any investment. Chinese investment groups should cultivate relationships with top professional firms in those countries they seek to invest in and bring on their staffs highly knowledgeable and skilled venture capitalists that know the targeted sectors."

Wottrich further explained: "In a free capitalistic economy, capital may move where it wishes and the private equity industry is on balance an efficient distribution agent for investment. On balance private equity investments overseas are not materially different from domestic investment, given the same rigorous level of due diligence and peer review."

He listed many large multinational equity groups such as Blackstone Group, 3i, Advent International, and Platinum Equity as successful investors when it comes to overseas investment. "The key factor is having boots on the ground in-country where these investments are made, along with strong relationships with the appropriate and relevant institutions in those countries," said Wottrich.

When asked about the operation of US Private Equity Groups ( PEGs), Wottrich said: "In the US private equity groups traditionally have been an alternative to the public markets and the banking system for business owners. Privately owned companies can turn to PEGs for equity to expand and grow, thus avoiding extra debt with traditional banks."

He pointed out that the extra risk that PEGs assume by standing in line behind the banks means that they reap higher rewards. In addition, he added, "PEGs also bridge the gap between shareholders equity and senior debt by investing at the Mezzanine level, meaning that junior debt (usually convertible into equity) is invested by PEGs to achieve a higher rate of return than recourse bank debt."

Regarding venture capital, the expert explained, "Venture capitalists (the people behind private investment groups) have been historically the equity engine that finances new business ventures in the United States and worldwide. The continuing miracle of Silicon Valley and the IT boom were funded by venture capitalists. Successful venture capitalists have to have the guts of a burglar and the vision of Superman."

It is generally perceived that US-based PEGs and venture capital funds are among the most successful in the world. When asked to explain their winning secrets, Wottrich said: "They typically specialize in vertical markets and develop extraordinary related industry knowledge that allows them to evaluate opportunities and measure risk. Rigorous due diligence and peer review are the basis for informed investment decisions."

When talking about the US government's role in investment in private markets, Wottrich described it as a more mixed story. He criticized that the government has neither the knowledge nor the personnel to make informed decisions regarding the winner and losers in the private sector.

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He used the recent influx of $32 billion in government spending in Green Energy as a case in point. "We are now starting to hear stories regarding how these funds distort the market, attract greed and corruption and lead to losses as market demand fails to appear for pre-funded ventures," said the expert.

He further explained, "with the recent melt down in US mortgage markets caused by the lack of due diligence at Freddie Mae and Fannie Mac, attention was drawn to the unregulated markets in credit default swaps and mortgage-backed securities. In many cases large private single purpose equity funds known as hedge funds designed and marketed these investment instruments."

So how does the US government regulate the investment of private funds? The seasoned expert pointed out that there is relatively little direct regulation of the private equity markets in the US, beyond various rules and regulations set forth by the SEC. "The recent Dodd-Frank financial services reform bill is supposedly designed to address some of these regulatory issues, but it remains to be seen if it will be effective," he added.