FOLLY NOT TO BE FULLY DILIGENT

October 2015

By: James Kallman & Iman Setiadi

Business and human rights were largely two distinct subjects at the start of the current decade; they aren’t today.
 

In general terms, due diligence is the care that a reasonable person should take before entering into an agreement or transaction with another party. The degree of this care is, of course, dependent on the complexity of the agreement or transaction. This scope can be extensive in the business world, particularly when a company is the potential target of merger, acquisition, privatization or other corporate finance transaction by a buyer.

Here every facet of a company’s operations are placed under a microscope, as due diligence delves much deeper that simply examining the financial reports and checking for legal compliance. Necessary to limit reliance on the vendor’s warranties, due diligence also involves investigation and evaluation of a management team’s characteristics, investment philosophy, and terms and conditions prior to committing capital. Due diligence is undertaken not just to determine the value of the investigation, but also to unearth any issues or potential issues. On completion, one should know exactly what one’s getting into, what needs to be done, what it will cost, and whether the subject is a desirable business fit.

Traditionally, issues have mainly arisen in the areas of accounting, legal and tax, as creative accounting practices or just plain ignorance can leave ticking time bombs. It needs various experts, preferably with experience in the sector under review to unlock the cupboards and shake the skeletons loose. Erroneous revenue booking that differs from the nature of the contract, failure to obtain necessary permits, or incorrect VAT treatment, and so on, all have the potential to result in major unforeseen future outlays.

The Internet’s rise has made an IT audit an integral part of due diligence, particularly in regard to security issues. Yet the indirect impact of the Internet that has had a greater e!ect, as the birth of social media has awakened the world’s conscience. Business and human rights were largely two distinct subjects at the start of the current decade; they aren’t today. Since the United Nations Guiding Principles on Business and Human Rights were unanimously endorsed by the UN Human Rights Council in June 2011, there is a growing awareness by both business and society that the two are inextricably linked.

Today, successful businesses need a social license as well as their legal license to operate, especially in the plantation and extractive industry sectors where land acquisition and treatment of indigenous peoples are major issues. In both these sectors, initial development has often been undertaken by smaller companies which paid little heed to the rights of local communities. These issues then surface when the operations are acquired by larger companies which having failed in their due diligence undertakings, are now paying the penalty. Indeed, a Goldman Sachs study revealed that some 30% of mining costs are related to social issues. Thus in planning a potential investment it pays to be thorough in defining the scope of due diligence to be undertaken, ensuring human rights issues are included. For those who fail to be fully diligent may well end up repenting their folly.

**This article was published in the Forbes Indonesia, October 2015. You can also read this article on Forbes Indonesia.