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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.

I can remember about 5 years ago here in the Jungle (Shenzhen, China). There was a new bar street that had just opened, and while there were about 7 bars, only one was relatively modern and western, and ultimately, the only one with customers. As the shopping mall to which the bar street was attached became more popular, so did the other bars, only because there was nowhere else to go. It’s the law of numbers in China, especially in cities like Shenzhen where there is so much money and relatively little culture.

But, this isn’t about lamenting the few choices or lack of culture in Shenzhen, China, it is about the discussion I had with one of the small bar owners, who almost never had any customers. The bar had a bad name and a picture of a dodgy kangaroo (it didn’t even look like a kangaroo) and was supposedly an Australian wine bar. In turns out one of the owners who put in most of the money lived in Australia and the bar was run by the other two owners who happened to be very clever sisters.

I asked one of the sisters one evening why they didn’t have any customers, and if she would like me to bring in some friends to make the place more popular. She emphatically said it wasn’t necessary because they were trying to make the bar lose money so that the absentee partner would accept a fraction of his initial investment in a sale to the sisters. She said that they knew the bar street was going to be really popular – and eventually it was standing room only every night – and that she and her sister would share all the profits. He eventually acquiesced, as he didn’t spend much time in China and had no idea what was really going on, and the rest is history.

I haven’t seen the sisters in quite awhile, but, I imagine them driving one of those new Mercedes SL Class Roadsters that are a dime a dozen here in the Jungle, smiling all the way to the VIP counter at the Bank of China.

One of the people I most respect in the world once told me, “nothin’ is ever what it seems.” That lesson is driven home to me every day that I spend here in the Jungle. I always tell my clients in China and anyone that will listen, do as much due diligence as you possibly can, peel back the layers of the onion until you reach the core, take your time, never be in a hurry and then once you make the investment or hire the factory or the distributor or the general manager, never stop doing due diligence. Never, never, never. That is if you really want to make money.

The post is by Frank Caruso. Frank Caruso is the head of the China Law Group at IPG Legal and has lived and worked in Shenzhen of over 12 years.

Private Equity firms, Hedge Funds and overzealous investors in Chinese companies beware. Needless to say I wasn’t surprised or disappointed when learning that “Hedge Fund Guru” John Paulson of Paulson & Co. lost a cool half a billion dollars on a Chinese company called Sino-Forest, listed on the Toronto exchange, after a report from the research firm Muddy Waters exposed significant reporting fraud at Sin0-Forest.

Now for those of us who are in the Jungle (China) on a daily basis, we could have saved Paulson a lot of money and Muddy Waters a lot of time and told everyone from the beginning to expect fraud and overstatement of resources, assets, and earnings and to do due diligence.

Then after you’ve done it, do it again and again. Yes there are good companies in the Jungle, with solid earnings, accurate financial statements and transparency and I am sure the opportunities for investment and stock trading can be promising. But, it is never what it really seems here in the Jungle and best to remember and dream about due diligence. The following from the editorial page of the South China Morning Post as always for your reading pleasure.

Investors need to have faith restored in companies being brought to market

The cloud of doubt over Chinese companies listed on the world’s stock markets is getting ever darker. Values took another dive last week after it emerged that American hedge fund guru John Paulson had suffered massive losses by ditching his entire stake in the Toronto-listed mainland firm Sino-Forest, accused by a short-seller of faking timber holdings.

His move has added to the damage caused by a series of scandals that have wiped billions of dollars off the market value of companies and damaged their credibility, regardless of whether they have been implicated.
But it is wrong to point the finger at suspect companies alone. Those who bring questionable firms to market should also be under the spotlight. Those are the investment banks, accounting firms, institutional investors and lawyers who vouch for the firms that are trying to list on stock exchanges. Just as during the global financial meltdown three years ago and the dotcom bubble of 2000, it is obvious that they have not done their homework. A number of firms that have doctored their books have been able to list.

A point is fast approaching where investors are unsure who they can trust. Large state firms and small private ones alike are being shunned. The values of many have plunged at least 20 per cent, and some by as much as 60 per cent, in the past few weeks alone. Quick action is needed by companies and the government to shore up credibility.

But a public relations blitz, in which firms make themselves as transparent as possible, and a concerted effort by authorities to improve domestic accounting practices are only part of the solution. Investors also have to have faith in the foreign entities that sign off on audits, underwrite initial public offerings and promote companies as sound deals. Conflicts of interest that abound have to be taken out of the process. Foreign stock exchanges seeking to attract mainland companies must also meet their responsibility to investors.