You're reading: Specific shades of due diligence in Ukraine

The reality of investment business in Ukraine is still such that the target investee companies quite often are undervalued for the reason that they are still not completely transparent, let’s say, if they are not black, they are quite often somewhat grey. While on one hand this may be frustrating, on the other hand this is one of the factors which makes the targets interesting to potential committed investors who are capable of fixing such a problem and to grow value.

Often such target companies are Ukrainian businesses which have never been audited. At the initiation of discussion with potential investors, they present managerial accounts as a basis to prove performance and a built financial model and valuation. Depending on the real color of the business (i.e. real level of transparency), such managerial accounts may contain larger of comparatively smaller portion of accounts which can be confirmed by usual audit.

Such reality creates difficulties as potential investors who still want to be able to trust the numbers presented to them in managerial accounts. And, of course, in these situations the number of “skeletons in the box” may grow over time. The solution demands a creative approach on conducting the due diligence.

While the reliability of such due diligence should be lower, it is still worth doing for certain cases. While in terms of financial due diligence, usually one relies on standard audit procedures, in such cases more attention to alternative and analytical procedures should be given. In many transactional cases with declared related parties, including natural persons – entrepreneurs may be identified and confirmed. In such situation, the preference is on the side of companies withstrong internal controls. The more the target company has internal control procedures and reliable IT infrastructure, the more credibility it gives, which is taken into account during due diligence. At the same time, certain operations, which have no legal background, remain unverifiable.

It should especially be noted that target companies who’s usual valuation might be adjusted at least for this part of the business which is not verifiable. The decision on such an adjustment depends on the level on trust from a potential investor, and such trust may be supported by deferred payment terms. In addition, during the due diligence, additional value adjustments are usually made based on the estimation of the additional amount of accrued taxes, assuming that a new investor will insist on more transparency. In some situations, such adjustments might even be a deal breaker.

The nice surprise for both parties during due diligence maybe the identification of inefficiencies in the business process and operations, elimination of which may partly or fully compensate the transparency effect in the future.Such findings may be incorporated in future strategic and operational planning.

Much like other paradoxes in Ukraine: The non-transparency of Ukrainian companies harm to their owners in terms on valuation, on the other hand, such a valuation makes investment in those companies quite attractive.

 

Author: Helen Volska, Managing Partner and Director, EBS

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