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Inside the Deal: Trends in Investigative Due Diligence

Toby Thomas, Ian Massey 9 March 2022
9 March 2022    Toby Thomas, Ian Massey

Dealing in Uncertainty

Diligence and integrity risks in a recovering world – fraud, corruption and cybercrime explored through a new lens.

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Following the uncertainty of 2020, 2021 was a boom year for private equity investment and M&A activity – which was reflected in record volumes of pre-deal work across the corporate intelligence market. In this article we look at some of the trends we witnessed at S-RM during this uptick of activity and explore what it may mean for 2022.


People pressure

Against a backdrop of continued low interest rates, high levels of private equity dry powder, and widespread stimulus funding, deal volumes in 2021 reached the highest level since the mid-1990s. The sheer volume of transactions was undoubtedly welcome for many in the industry. However, corporate intelligence firms have had to overcome several challenges presented by the demand surge.

The obstacles for leading law firms have been well-documented, with a tight labour market restricting opportunities for practices to expand sufficiently to fully meet client demand and placing substantial pressure on practitioners. The same market conditions have been true of the corporate intelligence industry, with teams required to demonstrate sufficient stamina to operate at pace and in a remote or hybrid working environment, without compromising quality.

Under such circumstances, the scale, established networks, and flexibility of providers have proved key to their resilience. The market conditions have favoured firms that have retained a deep talent pool of experienced pre-deal practitioners and regional specialists in-house. This has provided an opportunity for some consolidation of market share by the larger and more nimble consultancies.

The keys to success

The dealmaking surge also hastened a pre-pandemic trend towards the expediting of source enquiry timeframes by the global buy-out funds and their compliance counsel, with project deadlines often being compressed. This accelerated trend can be explained in part by strong competition for a restricted supply of assets – investors have either had to move quickly to beat the competition, or they have been engaging due diligence providers late in the transaction process because of a wariness of dead deal costs. In such circumstances, pre-existing industry networks and well-resourced teams have proved crucial to the ability to operate at pace and with agility.

Timeframes for DFIs and emerging market funds have typically remained stable, necessitated by the challenges of gathering intelligence in often more opaque intelligence-gathering environments.

Exploring the new

The increased competition for assets has led investors to explore new markets and sectors as part of their search for returns, sometimes exposing them to unfamiliar risks. In an era of restricted travel, the role of investigators with sophisticated local networks and broad in-house language capabilities has become indispensable. The exposure to new sectors has also caused an uptick in market entry intelligence being delivered alongside integrity due diligence. This is particularly necessary in frontier markets, as exemplified by the investor interest that blossomed briefly in Sudan between the revocation of US sanctions in December 2020 and the coup of October 2021.

 

"The increased competition for assets has led investors to explore new markets and sectors"

 

In more developed markets, private equity dry powder has been allocated to familiar targets, with recent interest in life sciences, health tech, fintech, hospitality, and digital infrastructure continuing strongly – and creating familiar grooves for investigation ahead of transactions, with a special industry focus on inducement payments to healthcare professionals, relationships with regulators, and acquisition of land sites, for example. Understanding financial crime compliance controls of a target company has remained a core part of the investigative mandate – and firms that demonstrate an ability to provide substantial detail on compliance processes, procedures and practices are those best able to provide investors with enough confidence to proceed with transactions. With increased institutionalisation of the investigative due diligence process, private equity sponsors are more often mandating that their portfolio companies execute diligence ahead of their own transactions, feeding a growing sub-market.

Net Zero

In November 2021 COP26 highlighted the Net Zero agenda, and the move towards decarbonisation. 2021 also saw a greater focus on ESG and an increased emphasis on the ‘profit with purpose’ agenda as the pandemic has continued to re-shape societal expectations. Whereas the Environment and the Social elements of ESG have historically been tackled independently, 2021 additionally saw a push towards a ‘just transition’, offering a win-win opportunity for both the ‘E’ and the ‘S’. The impact on the intelligence market has been the increased appearance of environmental and social issues within our investigative due diligence mandates – even on engagements where a specialist environmental consultancy is being engaged separately. With the Governance (‘G’) of ESG, we are seeing continued focus on broader issues, ranging from corporate culture and sexual harassment complaints through to the management of concentration risk in supply chains.

Looking ahead – yet more complexity for dealmakers

2022 started in the same vein as 2021, with private equity investment and M&A activity continuing at pace, despite the potential headwinds presented by rising inflation and the prospect of higher interest rates. However, the impact of Russia’s invasion of Ukraine in February on the outlook for global dealmaking is far from clear at this stage and adds more complexity to the dealmaking environment.

 

"Over the last two years, investors and corporate dealmakers have had to adapt continuously in a highly dynamic risk environment. Russia’s invasion of Ukraine presents a new crisis"

 

The invasion – bringing with it the prospect of a protracted conflict and tough sanctions – has already shaken financial markets. On top of this, both countries are leading suppliers of key commodities and manufacturing inputs to a wide range of industries. In Russia’s case, these include gas, oil, and several key metals used in aviation, vehicles, and consumer goods, and in Ukraine’s case they include grains used in food production and noble gases that are crucial for the global chipmaking industry. On top of the human suffering, the war threatens yet more supply chain disruption and inflationary pressures, just as the global economy was starting to look beyond the pandemic.

Over the last two years, investors and corporate dealmakers have had to adapt continuously in a highly dynamic risk environment. Russia’s invasion of Ukraine presents a new crisis. Investors and companies with interests that touch the region will need to consider a raft of new legal and reputational risks, ranging from the fast-changing sanctions and export control frameworks to the reputational risks presented by exposure – direct or indirect – to Russian capital or companies. The role of the investigator may again prove key.

To discuss this article or other industry developments, please reach out to one of our experts.

Toby Thomas
Toby thomas Director of Research, Corporate Intelligence Email Toby
Ian Massey
Ian massey ‪Head of Corporate Intelligence, EMEA Email Ian

Intelligent Business 2022 Strategic Intelligence Report

The evolution of strategic intelligence in the corporate world. Read S-RM's latest report.

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