The ‘Wild East’

A group of intelligence experts is building a due diligence practice in Russia and Central Asia.

By Sushil Cheema.

Conducting business in emerging markets can be grueling work for firms unfamiliar with cultural and business practices of the host country. Are the company’s representatives who they say they are? Are the practices corrupt? Are the accounts clean? What political connections are at play? These are all questions a firm must answer prior to making an investment.

Diligence, Inc., founded in 2002, is one organization to which private equity firms can turn when venturing in the former Soviet republics. Staffed with former investigative journalists, lawyers, bankers and, according to one source close to the company, former CIA agents (Diligence will neither confirm nor deny this possibility), Diligence is in the business of intelligence gathering in decidedly nontransparent markets. The company recently opened an office in New York, in part to target private equity firms with an appetite for emerging markets.

“There is tremendous demand in Russia and the former Soviet Union,” says Steven Fox, the managing director of Diligence’s New York office, adding that much of the company’s due diligence work also takes place in Eastern Europe. Prime areas for work, he says, are Russia, Kazakhstan and the Ukraine.

According to Fox, “The further east you go, the more wild west it becomes. There are often thuggish people involved,” he adds, noting the prevalence of so-called oligarchs in the business community. “You must have a deep understanding of who you are getting involved with.”

Rough characters aside, bureaucracy is another obstacle to making investments in Central and Eastern Europe, Fox says. For this reason, Russian private equity firms often acquire local companies using offshore entities. The Mediterranean island of Cyprus is one popular offshore filing vehicle due to its favorable tax treaties with Russia. Russian companies sometimes use these entities to create layers that disguise the true controllers and operators of a company, Fox says. Diligence works to unravel the layers and cut through the red tape to discover the real key figures in a company so that a private equity firm is fully aware of the true key players in a particular deal.

Fox points out one case his company worked on in Russia in which the dealmaker, who claimed to be the leader of a particular company, turned out to have only an 11 percent interest in the company. Finding out that information, Fox says, was key in helping their client identify the real decisionmaker in the transaction.

Cultural differences can come into play as well when dealing with other regions of the world, Fox says. Some Central and Eastern European company managers do not like to be investigated. But the process proves a potential investor’s seriousness and attentiveness. Essentially, doing research earns investors respect at the negotiating table, Fox says. “Trust but verify”—a mantra of the late president Ronald Regan—is the best way to operate, Fox notes.

Fees for services vary from project to project, Fox says, but they can range from $25,000 to more than $100,000. The average cost, Fox says, is in the five-figure range. Diligence has offices across the globe, including Washington, London, Brussels, Moscow and Berlin. The company’s main strengths, Fox says, include its ability to identify the key people in a given country or region who can provide help. Diligence staff members have typically built numerous connections of this sort during the span of their careers.

Last year, Diligence worked on a total of approximately 400 projects in about 50 countries, Fox says. Though private equity firms are not Diligence’s only clients, they do make up a significant portion of its dealings.

Diligence’s staffers report findings in all their “shades of gray,” says Fox. In many cases this means an investigation into, for example, whether a particular company has infringed a law, is not simply a matter that can be analyzed in stark black and white terms. Diligence’s more nuanced approach, Fox believes, is more advantageous to clients because it allows clients to see each situation more broadly.

“We try to be a deal facilitator,” Fox says, “not a deal breaker.”