During summer 2010 Analytical department published a set of articles dedicated to forecasting in human due diligence projects (part 1), (part 2). Our readers gave us a very positive feedback and I promised that one day I will return with my vision of the target company’s activity forecasting as a valuable part of background screening research. Now it is time for me to keep my word.
I’m not very fond of numerous disclaimers but I’d like to mention that the methodology I recommend and promote is a reflection of Analytical department’s experience of conducting background screening and investigative due diligence researches. It is the way we do our job serving our clients and as such it shouldn’t be treated as a requirement or standard applicable for all market players.
WHY FORECASTING IS IMPORTANT?
One who had experience on making decisions (even if he’s not an entrepreneur or top-manager) knows that the decision should be based on information valid and up to date by the moment of decision making and decision implementation. Let’s pretend that you have to cross the highway – will you rely on the information provided by the third party that an hour ago there were only 6 cars on the road? I doubt. In corporate background screening researches we often face very similar problem.
Let’s have a look at simple structure of in-depth corporate background screening report (click to enlarge).
In general it looks similar to the map of the battle with numerous combat units and the key to understanding of the report is the ability of the analyst (or decision maker himself) to foresee HOW these units will operate and what targets they will try to reach. If we know and understand these targets we will be able to form effective defensive or offensive strategy, else – the job was done for nothing and the client holds in his hands expensive, attractive but useless piece of paper.
First of all, analysing the case and the raw data we should keep in mind multidimensional table with following rows and columns:
Period of decision making and decision implementation
Usually the client shares his plans and it’s not a problem to identify the period of decision making and decision implementation. You will be surprised to know how often even reputable companies leave this question unanswered. Also it’s reasonable to mention that sometimes research results also have influence on decision implementation time (e.g. if we advise investor that the target company will be ready for acquisition only in half a year).
In our practice we use four grades for the period of decision making and decision implementation:
Short (up to 1 month) – the decision will be made as soon as the client will have the report and implemented almost immediately. Most regular assignments for screening of the contractor prior to the signing of the agreement can be treated as a “short range” assignment. If it’ll be a year lasting contract intelligent clients prefer treating the assignment as a middle-range. The core question of the research is how exactly the target business operates right now: Is it legally registered? Isn’t it connected with criminals or PEPs? Isn’t it claimed as bankrupt or faces default? Are there legal claims? Who makes decisions in the target company? etc.
Middle (1-6 month) – prior to the decision making, the client will have to discuss terms of contractorship/partnership with the target and the research should give him deep understanding of the business of the target and moreover he should understand how (if) target’s current status will (can be) changed during the period of negotiations. The same grade is ok for long-termed contracts if the business of the client is dependable on success/fail of the target. E.g. if the target’s business is highly personalized can we declare that key players don’t plan leaving the company in the nearest future? If by the date of the report the target operates as a group of companies can we rely on target’s promises that the structure is solid and there’re no signs of decay? etc.
Long (1-2 years) – if the client plans making business together with the target (organize partnership or sign strategic contract e.g. with the exclusive distributor or producer) current status of the target is even less important than its strategy and long-termed plans. It is rare when decision of this kind can be made in a week, decision making process can take up to 3 month and the period of the contract can be as long as the business will survive. What should be kept into consideration during researches of this type? We believe that in so-called “Long-range” assignments researches should feel the strategy of the target and its owners. How they develop their business? What do they expect from the partnership? What financial plans do target’s owners build? Are they healthy enough to keep their business under control for a long period of time? No doubt, in Long-range assignments one should examine the market (numerous instruments of marketing are applicable) and understands market’s trends, key players; examine possible changes in local regulations if they can influence the target etc.
Strategic (M&A deals, strategic opposition) – prior to merges and acquisitions in addition to all the above the researcher should build (forecast) strategy of joint enterprise and examine how both companies will influence each other and if (how) unclear advantages or disadvantages of both companies will lead joint business to success. This task is pretty close to management consultancy, but professional researches play a unique role in identifying hidden threads and possibilities, uncover possible long-termed fraud or manipulation of the market.
Flexibility of the target business
The next column of the table is flexibility of the target business. Depending on business flexibility we can assume if historical records can provide us will accurate information about target’s strategy and trends, if the client should be warned that research results will be valid for a very short period of time, what instruments of forecasting should be used etc.
I hope you have found this problem interesting.
In my next article I will continue describing our methods of target company’s activity forecasting. Looking forward for your questions and comments.