The most important risk you should always carefully analyze is the local sponsor. We have seen too many times where foreign investors deploy capital and not have any information on the local sponsor and their ability to comply with the requirements needed for development and put their capital at risk. Furthermore, always make sure to have an independent feasibility report completed for understanding of the market, its return opportunities in terms of market conditions, etc. It is always better to spend a few hundred thousand upfront to collect this information rather than risking millions in case the development does not progress the way you expect it to.
How could risk tolerance be best evaluated in outbound investments?
We are looking for opportunities for our first outbound investment deal in the U.S. and are wondering what should be taken into consideration when evaluating our risk tolerance in a foreign deal.
Risk tolerance is very much an internal consideration and is tied with the level of expected return. The higher the expected return for the potential investment, the higher the expected risk tolerance. Generally, cross-border or outbound investments will have the following risks, in addition to the normal risks of doing a local Chinese PE investment: currency risks, or how to get money out, how the changes in exchange rate will affect the value of the investment going forward, etc.; deal negotiation risks, such has additional transactional challenges on how to execute the deal, since the rules that the international target plays by will be different from the rules that Chinese investors are used to; management risks, or how to manage the investment after making the investment; and exit risks, with outbound investments generally expecting an exit that is not within China and hence will impact on the ability, difficulty and the valuation of the expected/potential exit.
Risk tolerance can be evaluated in a number of ways. You need to look at the deal(s) of interest carefully. The first step is diligence. To me, if considering an investment with a partner or co-venturer that you do not know well, learn about them. What is their history with other partners? What is their investment record? Carefully go through voting rights, dispute resolution and duties to make certain that you will not have nasty surprises. Also consider the tyoe of investment. Ground-up construction may offer the best returns, but it is the riskiest type of investment. Other top diligence items are: Does the project comply with the law? What are important provisions of leases? Are the assumptions on which the numbers are based valid and viable? Depending on the asset class you are looking at for specifics, I always look at an exit strategy to test possible early exits. Can a building be re-purposed? What new retail concepts can be a substitute? Things like this will provide you protection in the end.
There are a great many factors: macro-economic trends; interest rates; employment statistics; inflation statistics; market-specific information; risk/reward profile of investment; property-specific information, including proper positioning of an asset, work and cost needed for best reposition; how a plan would be executed and by whom. That's part of what you need to consider. If you have not done this before, a strong local partner or advisor might be a way to evaluate risks, opportunities and how best to proceed.