China is the world's second largest economy. While the country remains a top investment destination for various global corporations, there are no short-cuts to success in a complex market.

With any type of investment, particularly by overseas companies, it is a smart move to conduct thorough due diligence. Lack of sufficient knowledge on a company's background or even the country and culture can pose numerous risks. Many companies fail to perform even a basic level of due diligence that may result in losses from reputation damage to monetary and time losses.

Prior to establishing a business or conducting any kind of business transactions, examine the transaction's scope to determine how comprehensive the due diligence should be. Due diligence can be divided into three areas: on companies, on individuals, and on the market and environment.

A general guide to due diligence on a company includes research on the company's background, history, corporate structure, and litigation involvement. Further research on the company's management and shareholders can reveal possible conflict of interests with the business and individual litigations.

Another area of due diligence is to examine the individuals. This includes research and verification of an individual's background, employment history, financial status, assets and businesses, and directorship. It is a useful tool prior to establishing any individual business partnerships.

In a company setting, individual due diligence can be applied to the hiring process in getting the right candidates on board. Pre-employment screening is a useful tool as a first line of defense to safeguard a company from potential risks. Similar to due diligence for individual business transactions, pre-employment screening would examine a candidate's employment history by conducting a thorough resume verification and reference checks. By focusing on both written and unwritten information, the hiring manager will be able to confirm the accuracy and discover any hidden details to affect the hiring decision, such as employment gap, conflict of interest, bankruptcy, and civil litigation.

The last area of due diligence to examine is the market and environment. Having in-depth knowledge of the market will provide vital information as to what the opportunities and challenges lies ahead, as well as the area's rules and regulations, competitors, and potential problems which may affect the business. Similarly, the environment will suggest potential threats which may raise red flags for investors. It is common for foreign investors to find everything optimistic on paper but a simple site visit to reveal the counterpart is far from expectations.

In a recent case, a renowned European company conducted due diligence on a potential supplier company in China. Investigation results showed 17 lawsuits were filed against the supplier company mainly for loan and sales contract disputes among other woes. Moreover, workers revealed that there was a problem of wages in arrears and unpaid overtime. Due to this problem, the factory production was low and workers were demanding for their wages and refused to work. The results through the three areas of due diligence conducted suggests that the supplier company may be financially unstable which raised red flags for the foreign firm before entering into a risky partnership.

China's economic rise remains irresistible to foreign investors. Its legal systems have made continuous progress to improve business friendliness, yet insufficient regulation is still a concern. As with any business investments, preparation and prevention is the key to success.

The author is the managing director at Verity Consulting Limited. The views expressed are entirely his own.