Over the past few decades, due diligence practices and international trade activities have undergone significant changes. For example, companies have implemented increasingly sophisticated tools to evaluate risks and opportunities associated with corporate acquisitions. At the same time, firms of all sizes have developed complex and very efficient global supply chains. But serious problems persist.
Improvements Have Benefited International Traders
At least since the mid-1990s, due diligence practices have evolved, adding new concepts relevant to current business demands. For instance, financial audits have provided an increasingly savvy set of expectations and requests in order to better understand the financial circumstances of potential merger partners or purchase targets.
Similarly, newer audit areas, like the compatibility audit and reconciliation audit, have become commonplace. The goal, of course, is to avoid failed mergers. But these developments also have given potential purchasers unprecedented insight into acquisitions.
Meanwhile, since the mid-1990s, companies of all sizes have become increasingly reliant on imports and exports. In 1994, the North American Free Trade Agreement, NAFTA, gave many smaller companies around the country a convenient path to establish international supply chains. Companies seized this chance. The result: trade among NAFTA partners more than tripled since the agreement came into force.
Companies that historically only purchased materials domestically now typically don’t think twice about sourcing in Mexico or Canada, as well as locating facilities in these countries. And the rise of China as a major source, as well as a manufacturing platform, has accelerated the trend toward greater international engagement among American companies.
Major Problems Persist
Over time, many U.S. companies have become completely reliant on imports of materials, parts and components necessary to manufacture or supply customers. And the magnitude of this reliance is not always clear within companies until a catastrophic event occurs.
For example, the natural disasters last year in Thailand that disrupted deliveries from Toyota and Honda, and the earthquake and resulting tsunami in Japan that significantly damaged U.S. supply chains, revealed risks not generally contemplated. But other, less obvious risks need to be assessed as well.
For a company conducting due diligence activities, it’s important to identify often-significant international trade risks well before they may be exposed. This, however, is not always an easy task.
Companies that understand international trade operations often have an incomplete picture of the risks they face. Why? Trade activities often are viewed in terms of individual transactions and not in totality.
Over time, this can come to represent millions of dollars in potential tax liabilities, in addition to significant administrative costs attempting to correct weak processes. For example, a $1,000 issue on a single entry typically will not be viewed as the very significant $5,000,000 issue over the period of years. And there are other concerns.
International trade activities are governed by regulations that generally involve unique documents and terminology. This adds complexity for those not familiar with trade matters and can lead to an inability to accurately review and assess data, and identify potential anomalies.
This can place non-specialists in a quandary since individual shipments are unlikely to meet thresholds for reporting. A solution may be a due diligence report that notes significant import/export activity at the target company, and whether that company has been subject to a “material” enforcement action in the previous five years. This, however, does not always get to the root of the potential risk
To fully grasp and evaluate the risks from global business, it is important to ensure that the operations are evaluated by professionals with intimate knowledge of the applicable regulations, documents and terminology. In most cases, this evaluation should be a subset of either the legal and environmental audit or the financial review.
However, in all cases the evaluation must include both the transactions and the company’s processes supporting the transactions. This is vital since regulating agencies for both imports and exports have instituted “risk based” approaches to compliance that require companies to have sound, audited processes in place to be considered “low risk.”
From both a cost-effectiveness and an efficiency perspective, there is no substitute for having this review conducted by people with a sound understanding of international trade law. Professionals who have reviewed thousands of individual transactions and processes at dozens of companies generally are able to quickly and efficiently identify potential issues.
Nothing is more disappointing than acquiring a company that suddenly incurs operating disruptions and unexpected costs, or discovering entire business segments that are not economical. In many cases, issues leading to these eventualities could have been prevented by a sound due diligence effort. Utilizing improved processes in due diligence practices by well trained international trade professionals can help identify risks and ensure that acquisitions go as smoothly as possible.
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