Wednesday, January 25, 2012

Basics for Partnering with a Chinese Company: More than Just Due Diligence

The following post was written by, Tom Coyner, MBA, one of IPG's senior business advisers.   Tom has has worked in Asia for over twenty years.  Please read the following post in conjunction with the articles listed at the end of this articles for needed due diligence prior to engaging in any arrangement with Chinese company. 

Many foreign companies in China, for practical reasons, choose to partner with a local company to market, sell and support their products and services. While once upon a time there were legal requirements to do so, now China, in most industries, has a relatively free market in this regard.

Frankly speaking, finding a China partner company can be ridiculously easy. Finding a successful partnership, however, can be ridiculously difficult. That is, many China companies are willing to partner for all of the wrong reasons. And this may be said for a like number of foreign firms attempting to do business in China.

Many China firms look at partnering with overseas companies as a cheap and easy way to  become "international," or at least more international, via this foreign partnerships. Partnering can add to their market prestige and provide new products and services the domestic competition lacks, or that they cannot easily develop on their own. Thus, in their reasoning, sales may often be secondary to domestic market positioning.

Foreign firms often regard the China market as the most important international market for the next decade and that if they are not in China at this time, they better be in China quickly.   As a result, they may be tempted to do a "quick and dirty" market entry, finding a China company selling into the right market niche and boasting a glib speaker of English or some other appropriate foreign language. After the China joint venture agreement is inked, its back on the plane without much expectation to return to China for another six or even twelve months.

These two descriptions are stereotypes, but unfortunately they are closer to the reality mark than many Chinese and foreign firms may like to admit. So what may be a better way to find and develop a successful partnership?

First, look carefully at the company and the key people on whom you will depend. Many China firms look absolutely great on paper, but it will be a couple of key people who will largely determine whether your joint venture will succeed. Certainly the Chinese company needs to be financially stable and credible in your market niche. At the same time, that company must have individuals with sufficient authority to ensure commitments with the foreign company remain at a mutually appropriate priority level.

Key people include the CEO, marketing or planning director, sales director and product support director. If you do not perceive a personal stake in the venture for each of these people, your partnership with the Chinese company may be in danger from the beginning. You should be able to accurately articulate from the Chinese perspectives why this venture is personally important to each key person. Then you should honestly compare their motivations with your own. Even if you like the company and the people, if there is a not a good match, its time to move on.

Second, consider how and with whom your company will be able to communicate. Assuming you do not have Chinese speakers in the home or regional offices, it can be critical to ensure there are capable English speakers at least in the marketing/planning and product support groups. Ideally there should also be a strong English speaker representing the China sales team, but that may be harder to find. Naturally, the larger the company, the more likely the China partner will have employees with foreign language skills.

That brings us to our third point: It is important to partner with the appropriate-sized Chinese company. It is surprisingly easy to go too big or too small. The big companies are usually part of the giant business conglomerates. Their prestige often brings instant credibility to the market for your products, but their ability to sell to other companies within their group is usually exaggerated.

Furthermore, big companies typically have annual or even more frequent organizational reshuffles. The net result can be that the Chinese in whom you have invested a great deal bringing them up to speed on your company and products may one day, perhaps without notice, be reassigned to other departments. Major corporations anywhere in the world tend to be systemically arrogant, holding the unstated assumption that you need them more than they need you.  Chinese companies are no different.

Partnering with too small a company, meanwhile, may entail another set of traps. The good news is that they may need you as much as you need them - or even more so. Consequently, insure that they will be putting enough skin into the game to consider you more than simply another arrow in the quiver. The personnel you train are probably more likely to stay dedicated to your products than those of the larger firms.

However, if you are selling large capital assets, these smaller firms may themselves having to partner with other local China firms to be credible producers, marketers and supporters of your products for future customers. Additional, de facto partners mean smaller pieces of the shared pie of profits and/or higher pricing that may make your products less competitive.

Finally, even if you are able to get the right mix and balance, you have just begun the partnership. Chinese, generally, look at all written agreements as just the launching of a new relationship that will need to adapt to unforeseen circumstances. So the foreign firm should not be shocked if, almost from the very beginning, the Korean partner asks for variances from the written partnership agreement as the first real sales opportunity approaches.

Such requests for variances might be justifiable in some cases, but there are also times when the Chinese partner has not done adequate due diligence in selling or preparing support for the foreign products. At these times, one needs a reasonable adjudicator who can advise from ground zero on how to handle variance requests.

Established foreign firms usually have local representative offices with enough employees to act as the local eyes and ears and advise home office management. Those firms not yet ready to set up representative offices can outsource to consultants.  IPG works with some of the leading consultants in Asia. 

Some articles that may be of interest:
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SeanHayes@ipglegal.com

Thursday, January 19, 2012

South Korea to Buy Yuan-Denominated Assets

Heung-sik CHOO, director-general of the Bank of Korea (BOK) stated to Bloomberg that the BOK may purchase RMB-denominated (Chinese yuan) assets. 

The news may trigger most Asian economies to consider more investments in China-currency denominated assets. At present, the only other developed country that has announced plans to invest in RMB-denominated assets with foreign currency reserves is Japan.

The Director General noted that the BOK will begin by only investing in Chinese government bonds.  The investment is expected to be modest.

The China Daily has reported on this issue today and noted:
The BOK obtained a Qualified Foreign Institutional Investor (QFII) license in late December and has gained the approval of its counterpart, the People's Bank of China, to buy bonds, Choo was quoted by Bloomberg as saying.

The National Pension Service, the largest investor in South Korea, recently said that it received approval from China to invest in the Chinese securities market. Korea Investment Corp, the country's sovereign wealth fund, also said that it had received a QFII license.

Last month, Japanese Prime Minister Yoshihiko Noda announced plans during his visit to China to buy Chinese government bonds. Media reports said that the investment might be worth about $10 billion.

Japan's investment would be the first time that a developed economy used its foreign reserves to buy yuan-denominated assets.

Analysts said that Japan's move represented a significant step for the internationalization of the yuan, transforming it from a trade settlement currency to a reserve unit.

Chen Zhiwu, economics professor at Yale University, said that the purchase of Chinese government bonds by Japan and South Korea reflected China's increasing investment and trade relationships with the two countries.

However, Chen said, "the increasing foreign purchase of the yuan-denominated assets could put a burden on China's own huge foreign reserves.

"So it is unlikely for the yuan to become a true global reserve currency as long as China's trade surplus remains high."

The China Daily article may be found at: South Korea's Central Bank Weighs Purchase of Yuan Assets.
Will the RMB be a reserve currency?
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SeanHayes@ipglegal.com

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SeanHayes@ipglegal.com

China VIE Structure has Become more Risky for Investors

The Chinese Securities Regulatory Commission (CSRC) has warned investors, through an internal memo, of the use of variable interest entities (VIEs).

The VIE structure has been used by foreign investors to enter industries where China has restricted or prohibited investment by foreign nationals. Typically, Chinese founders of a Chinese company who hold the license to do business in China in a heavily regulated industry will invest in an offshore company along with foreign investors. The offshore holding company will, then, create a wholly-owned subsidiary of the holding company in China. This company will enter into agreements with the original Chinese company holding the business licenses. The offshore holding company, thus, may control the domestic companies via the contracts.

The memo has alleged that VIEs may be a threat to national security. The memo has not, yet, been officially endorsed by the CSRC or the State Council, but if the memo is (could be going through the procedure now) we could see a quick backlash by the government. The backlash could include the invalidation of agreements between the subsidiary of the offshore holding company and the China company holding the licenses.

The backlash is not likely to come soon and the memo seems to insinuate that present VIEs will be safe, but structuring any new deals in a VIE structure is dangerous business than can be handled in other less risky manners.
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SeanHayes@ipglegal.com
IPG is engaged in projects for companies and entrepreneurs doing business in Bangladesh, Cambodia, China, Korea, Laos, Myanmar, Philippines, Vietnam and the U.S. www.ipglegal.com

Wenzhou, China to become Private Capital Mega City? A Test City for Reform

Wenzhou, late in 2011, made a proposal to the provincial government to commence regulating private financing.  The cities hopes to become the leader in China in private capital financing.

The Wenzhou government intends to create private banking and financing institutions including private capital management, micro-finance and private equity distribution centers.

The city was motivated to reestablish itself, after numerous debtors have turned to an underground market for financing to solve short-term liquidity issues caused by the world financial crisis. 

The city, however, may be a role model for the country.  The underground financing market is well-known.  The market has prospered because of the inability of these type lenders to gain business licenses.  A more liberal approach to these lending sources could increase transparency and act as a catalyst for the creation, in China, of more legal and transparent lending sources for SMEs. 
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SeanHayes@ipglegal.com

Wednesday, January 18, 2012

China Rejects North Korean Law on Yalu River Free Trade Zone

The tension between North Korea and China is rising.  China has rejected a proposal by North Korea to jointly develop two islands on the border of China and North Korea.  The islands are at the mouth of the Yalu River.

The islands, Hwanggumphyong and Wihwa were intended to act as a free trade zone for China manufacturers.

The Chinese government rejected the offer because of alleged less than fair terms and possibly the insistence on the North to keep its nucleur weapons.

It is anticipated that without aide from China and South Korea, the regime would have little hard currency and, thus, would be unable to purchase crude and other foreign commodities. 
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SeanHayes@ipglegal.com

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SeanHayes@ipglegal.com

Who Caused the Financial Crisis: Wall Street or China?

Foreign Policy has an interesting article explaining how China contributed to the U.S. and Eurozone financial issues and how China can, also, assist in getting the world out of this financial mess.  An excerpt is below. 
But these explanations for the twin crises in the United States and Europe simply ignore the facts. Subprime mortgages with exotic features accounted for less than 5 percent of new mortgages in the United States from 2000 to 2006. It is therefore highly unlikely that they were solely responsible for setting off the housing boom that ultimately went bust. The explanation offered for the crisis in the eurozone overlooks the fact that Spain and Ireland -- two of the weak links in Europe today -- were actually paragons of virtue in terms of the Stability Pact. Both countries boasted budget surpluses in the years leading up to the crisis, and both had debt-to-GDP ratios of roughly 30 percent, or only about half the level that was permitted under the Stability Pact.

The immediate cause of the housing bubbles in the United States and the eurozone periphery was not regulatory oversight failure, but the precipitous drop in interest rates in the early 2000s. And the country that bears partial responsibility for depressing interest rates is a traditional punching bag in the American political arena, one that has somehow avoided most of the blame in this round: China. The ascendance of the world's most populous country in the global economy not only changed the terms of trade, but it also had a considerable impact on the world's capital markets. . .

he economic cataclysms in the United States and Europe may seem driven by their own peculiar circumstances at first glance, but both would have been much less severe without China's ascendance. Without China as a major economic player, the low interest rates at the start of the millennium would have been more effective in kick-starting the U.S. economy, and the Fed would have begun raising the Fed funds rate much sooner, with the European Central Bank (ECB) following suit. Part of the manufacturing that took place in China would have been preserved for the United States and Europe, aiding economic growth in these regions and lessening the need for low interest rates. And without China's rise, inflation in the early 2000s would have been higher, propelling the Fed and the ECB into action. But more importantly, China and other emerging economies' savings would not have depressed long-term interest rates worldwide.
But all is not lost. One consolation is that the past decade of loose living in the United States and Europe has done much to lift hundreds of millions of people in China and India out of poverty. No development aid program can stake a similar claim.

Another consolation of sorts is that economic growth in the emerging economies will likely go a long way toward buoying the global economy this decade. Apple recently experienced firsthand how ferocious Asian consumers' appetite can be when near riots broke out at its flagship store in Beijing after it postponed the launch of the iPhone 4S due to crowd size.

Other U.S. businesses are also eyeing Asian markets as a source of demand for their products and services. As China's economy continues to mature, it may just be the economic engine that the United States and Europe need to dig themselves out from under their mountain of debt.
 The Article by Foreign Policy can be found at: How China's Boom Caused the Financial Crisis

What do you think?
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SeanHayes@ipglegal.com

Tuesday, January 17, 2012

How to Lose your Intellectual Property in China by the Wall Street Journal

Geoff Nairn of the Wall Street Journal wrote a great article entitled the Patents are Virtue: Countering the Counterfeiters.  He notes in the article that: "China is not the only source of pirated goods but it is by far the worst offender, accounting for 85% of counterfeit goods seized in the European Union last year, according to the European Commission."
  
The article has great advice on some of the reasons why companies doing business in China are plagued with IP issues.  The article quotes advice from Dan's china law blog on the ABC of Losing Your IP in China.
A: Failing to use employee invention agreements. These specify that any invention made using the company's time, material or facilities belongs to the company, not to the employee.
B: Thinking that patents are the only IP that matters. Western companies underestimate the importance and value of trademarks and trade-secret agreements in China.
C. Neglecting the three Ns. Non-disclosure agreements stop suppliers disclosing IP to third parties. Non-use agreements stop Chinese contract manufacturers setting up as your competitors. Non-circumvention accords stop contractors selling direct to your customers.
What do you think?
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SeanHayes@ipglegal.com

China May Be Deep into a Bubble According to the Financial Times

IPG has seen great development in China over the past decade, but worries that many recent developments projects are occurring to quickly and without proposer feasibility studies.   Opportunities abound in China, but the recent issues with retail and residential space notes an issue that can kick investors in the butt - China has a real estate bubble that may be ready to pop.   The bubble may be bringing opportunities to the more creative investors.

The Financial Times has noted that:
As crowds shouted and pushed for the latest iPhone in Beijing on Friday, a glitzy mall across the street was bathed in silence, with just a handful of shoppers hunting for bargains.

The frenzy at the Apple store underscored the rise of the Chinese consumer, a development that analysts say is needed to support the global economy and make China’s growth more sustainable.
But the empty SOHO complex cast a different light on what is happening in the world’s second-largest economy: consumption is rising, but not nearly as fast as vast shopping centres are being built.
A boom in the number of malls without a matching increase in actual shopping gets to the heart of what analysts see as the fundamental problem of the Chinese economy: too much investment, too little consumption.

“There was an exponential two or three years where record numbers of malls were built around the country,” said Frank Marriott, senior director for Asia at property consultant Savills. “It has to take a bit of a breather.”

Within a half-hour walk from Beijing’s fashionable Sanlitun district, eight shopping complexes have opened in recent years. While one mall called the Village – home to the Apple store that was pelted with eggs on Friday – is bustling, many of the others are visibly struggling.
We will be posting articles, in the near future, for investors interested in capitalizing on the Chinese real estate bubble.
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SeanHayes@ipglegal.com

Sunday, January 15, 2012

China Experts are Everywhere?: According to the "Experts" Only

Dan Harris, of one of china law blogs, had a post on Chinese students in the United States that was commented on by Hidden Harmonies, a blog I follow.  The Hidden Harmonies blog notes that:
Dan Harris over at China Law Blog made a bold post today relaying complaints students at the University of Washington have for their fellow international students from Mainland China. He qualified that the complaints were directed at students from China and not of students with Chinese ethnicity. He also qualified the students whom he got the complaints were “sophisticated, intelligent, and well-traveled.”  . . .
Harris could have found a few Mainland Chinese students and get their take. Why doesn’t Harris have some Mainland Chinese students at University of Washington who he can readily talk to as he did others – after-all, his firm specializes in doing business in China.
You’d expect his firm smart enough to have Mainland Chinese students who understands Chinese law and studying international law (or something related) at University of Washington to intern for his firm. Without balance from the Mainland Chinese students perspective, the article panders to the nasty views in America towards ‘China.’ The complaints read a lot like the China bashing that exists in the mainstream American press; ignorant, some truths, and some lies.
I agree with Hidden Harmonies.  The post by Dan shows the problem with most "experts" on China.  Most experts are sitting in America and occasionally catches a flight to China.  To be fair, Dan does have one American lawyer living in China who speaks fluent Chinese.    However, without a presence in China and without living and breathing China, how can one understand the unique nature of doing business in China?  You must have an understanding of the Chinese from more than just books, blogs and a few visits each year.

This is not meant as anything negative to Dan.  Dan is wonderful at what he does and I have a great deal of respect for him because of what he built.  However, the problem reflected in the quote above is a problem common with those that take, primarily, an American viewpoint (because of, often, a lack of Chinese experience) to issues related to China.  This viewpoint, sometimes, leads to issues for clients of law firms.

I don't pretend to be an "expert" on Chinese Law.  However, my partner is a true China expert.  As you can see from the profile to the right, you can clearly see what my function is with regard to this blog.  I am the minion of a true expert on China Law - Frank Caruso.

I am not an expert, because I have been sitting in Korea for the last decade.  Like Dan, I don't speak Chinese (I have been with Dan and his Chinese is as good as mine -bad), don't spend much time in China (like me, I fly out from Korea a few times a year to China)  and have few interactions with Chinese other than the many "westernized" business flock.  I have met few Chinese law students and had few interactions with the Chinese (other than businessmen).

My partner (head of China Practice Team), however, speaks Mandarin, has Chinese staff, has lived in China for over a decade and even represents Chinese clients.  He has even been an adviser to the Chinese government.  He lives and breeds China and is, thus, a true China Law expert. 

Read Frank's posts and you will see the less textbook approach to issues and also more nuanced understanding of the Chinese and the unique way they do business.  Frank, as he likes to say, lives, works, loves and hates the "jungle."  His affectionate name for Shenzhen, China. 
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SeanHayes@ipglegal.com

Thursday, January 12, 2012

The Best Guide to China in 10 Minutes - Not Less

The link below is to a great summary of modern China. The link is to a 10 minute animation that is surprising neutral, entertaining and informative.  

The link can be found HERE. 

Wednesday, January 11, 2012

China Labor Law Enforcement Guideline by the Chinese Supreme People's Court

This past week the Supreme People's Court of China officially announced that it will impose much more serious criminal punishment on those that are involved in violations of workplace safety laws that leads or may lead to harm to workers.

We expect to see lengthy jail sentences handed down to more corporate executives and, also, higher fines. 

The announcement comes at no surprise to us at IPG because of increased media exposure of work place accidents and, also, demands by Chinese employees. 

Foreign companies operating in China that are in industries that are perceived as having a dangerous working environment should immediately do a complete compliance workplace safety audit by either a law firm or a business consultancy  with significant experience doing this type of business in China.
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SeanHayes@ipglegal.com