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JVs in China:Preparing for What Foreign Partners Will Worry About

Art Dicker

Partner

Pacific Bridge Group

Art@pacbridge.co

Note: This article is addressed to Chinese business owners, management, and other stakeholders considering a joint venture in China with a foreign partner.

China technology and manufacturing companies have come a long way in the last several years developing their own capabilities and being able to address needs of the local market. But for many there still is a win-win opportunity to partner with a foreign company and the advantages it brings in state-of-the-art technology, product design and quality, and international branding. We see this especially in the areas of automotive and manufacturing where we focus.

For small and medium sized companies, M&A is often too expensive. And being a contract manufacturer/distributor or simply licensing the technology for local use may leave the Chinese partner feeling that the foreign party is not fully committed to the success of its venture and the China market. For the Chinese side, why invest so much time localizing the product and developing a sales pipeline when the foreign party can seemingly walk away at any time?

Its not surprising then that Chinese companies often prefer a joint venture where both sides have equity incentives to make the venture work. However the foreign party often has some common concerns based in part on stories they have heard and impressions they have made in the past.. At Pacific Bridge Group, we believe that a bad Sino-Foreign JV is still by and large the exception not the norm. For Chinese companies with clear minds and pure hearts, how to make the foreign party feel more comfortable over the governance, finances, and IP of the JV?

Many foreign parties have been told the old Chinese saying “same bed, different dreams” (同床异梦), and that this especially is the case for partners trying to work together in a joint venture in China.

Here are some common misunderstandings about Sino-foreign JVs that the foreign party may worry about:

1. Even though the foreign party has 51% or more of the equity and control the board of directors, will it have actual control on the ground?

Chinese parties often hold the specific power to (a) appoint the legal representative of the JV which can bind the JV to contracts and other legal and government documents and (b) appoint the general manager to whom the JV staff on the ground may develop more of a personal relationship with. As the legal representative and general manager needs to submit documentation and conduct the day-to-day business of the JV, the Chinese party often feels it should, as a matter of convenience hold the chops of the company (which in and of itself can bind the company to contracts).

2. How can we maintain transparency on pricing, customer requirements, and supply chain management?

There are some extreme stories which make news outside of China of the Chinese side marking up contract prices with relatives’ suppliers or setting up separate companies with similar sounding names and diverting customer orders to it.

3. Will giving the Chinese side too much access to our product or technology allow them to copy it, and even compete behind the scenes?

Certainly both sides of a JV should not be competing with each other. But setting up a JV usually is a net benefit proposition for both sides with the China side specifically providing market access or a cost basis the foreign side cannot do on its own. As a secondary benefit each side does learn more about the product development (for the Chinese partner) and the market (for the foreign partner). That is rather unavoidable if the JV is to work well in the first place.

4. Can the JV meet our compliance standards as a global company?

The Chinese side will usually be responsible to get necessary approvals for the JV’s land requirements and obtain government subsidies and tax breaks, etc., and win contracts with customers including state-owned companies. The foreign party will have worry about compliance with international rules like the US Foreign Corrupt Practices Act or the UK Bribery Act as the JV will be a part of the foreign party’s corporate family and it will be responsible for its actions. In fact, it will be responsible for its actions in China as well and if the foreign partner already has other business in China, how would any trouble at the JV impact that business? China is enforcing its own compliance rules more and more robustly in recent years. (As a side note to the Chinese party, even if you have good relationships with the government, there is no need to stress this with the foreign party. You’re an established, profitable Chinese company. They will assume you have good relationships with the government. But boasting about it will only make them nervous.)

These are the questions and concerns facing a foreign party looking at entering a JV in China. Would it be better off just setting up its own 100% owned subsidiary, a WFOE, and running the business itself? Is this really the best option? Building a brand new business from scratch? Are all Chinese partners really so bad?

What can you do to get past these perceptions of JVs?

1. Show a roadmap for success and exit.

Prepare a roadmap and show how both parties can win. Prepare good faith financial projections on how much capital is needed and what the sales expectations are. Prepare a budget forecast which includes ongoing technical support from the foreign side for the foreseeable future. But also present exit options for either side over the long-term. This includes downside scenarios and clearly defining what are to be considered unacceptable levels of business losses in consecutive years, production below targeted levels, etc., and have these agreed upon and set in the JV contract as potential termination triggers to avoid the foreign party’s fear of having no way to get out of an unprofitable venture without the Chinese sides’ approval.

2. Be prepared for due diligence.

Be organized and open to due diligence. Yes, even though the joint venture will be a new company, the foreign side will want to do due diligence not just about the assets you will contribute to the JV (equipment, factory capacity, managers) but also your business itself. Are you financially strong, how do you protect your own IP, are you in compliance with labor laws and social insurance policies, can you even provide customer references that the foreign party will trust? Be ready for the kinds of questions they will ask and the kinds of documents they will request. The more organized you look, the more trusted you’ll seem as a partner they can work with. This is not to say you should proactively offer due diligence materials without being asked for them, that will come across as too well planned out. Just wait for the inevitable requests that their advisors will be pushing them to get, and don’t show any hesitation to respond in full.

3. Be prepared to give up significant control.

Be prepared to offer the foreign side control of the board and appointing the legal representative. Try to retain the right to appoint the general manager while the foreign side appoints the financial controller and controls the chops. Together with the right of the foreign party to be able to conduct routine audits on the JV’s business practices, this should be enough to give the foreign side comfort for a 51%/49% JV ownership setup or something similar.

As protection for the Chinese side, you can always ask (and should ask) to make certain kinds of major business decisions to require unanimous board approval and be able to fall back on that. Remember that the JV is a Chinese company operating in China and rightly or wrongly, the foreign party will automatically assume you have a home court advantage in case of any disputes. If you can put yourself in their shoes, you will better understand how to address their concerns and come to a compromise on the JV setup that both sides can feel comfortable with and just focus each sides’ energy on making the business successful.

About us: Pacific Bridge Group (Shanghai Lanhong) is a China cross-border business advisory firm. We help Chinese companies search for and reach potential international business partners through M&A, joint ventures, and VC investments and advise on subsequent transactions. We generally know technology and manufacturing businesses best, with a particular focus on the automotive and IoT sectors.

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