Joint ventures in China – getting it right

July 2016  |  FEATURE  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

China has long been an attractive investment destination for Western companies, and given the country’s growth in recent years, valuations of Chinese companies have grown considerably. With competition for outright acquisitions of Chinese companies increasing, many businesses have turned to joint ventures to gain an inroad.

However, many analysts argue that for a company looking to enter the Chinese market, a joint venture should be its last resort. Joint ventures can be a risky proposition, but they can be a valuable tool for companies hoping to crack the Chinese market, if done properly.

Why joint ventures?

A successful joint venture can present valuable opportunities while reducing costs and risks across the board. By forming a joint venture, companies gain access to new markets and distribution networks, along with new (and often greater) resources – both human and non-human. For companies entering a new market, the risk of borrowing additional funding or seeking outside investors is diminished. Furthermore, the flexible nature of joint ventures makes them popular in volatile emerging markets. Their temporary nature can be appealing to companies operating in risky waters.

Why China?

The size of the market in China and the speed at which the national economy has developed over the last 20 years makes it an obvious destination for investment. However, with competition for assets growing, and with many Chinese sellers unwilling to sell 100 percent stakes in their organisation, a joint venture may be the only viable option.

Not only are joint ventures popular with companies embarking on investment into the Chinese market, they are also popular with the Chinese authorities. Depending on the sector in question, a JV may be only way to register in China if a certain business activity is still controlled by the government. Restaurants, bars, building and construction, car production, and cosmetics are just a few of the industries in which foreign companies would need to seek a joint venture with a local partner. Equity joint ventures are the second most common manner in which foreign companies enter the China market and the preferred manner for cooperation where the Chinese government and Chinese businesses are concerned.

As certain Chinese markets liberalise and allow foreign investors, the local expertise offered by Chinese joint venture partners could prove invaluable. By entering into a joint venture, overseas investors may benefit from marrying the expertise and knowledge of local conditions from the Chinese side, with the advanced technical knowledge and management expertise they bring to the table. Local partners, for their part, welcome this added sophistication in their domestic offerings. As such, strategic JVs can bring success and mutual benefit to both partners.

That said, JVs can be risky endeavours for companies to pursue. The structure can be very complex, particularly in a jurisdiction like China. Accordingly, companies must take their time and ensure that they get the deal right. Crafting a fair and equitable joint venture agreement is crucial, as is ensuring that you have the right Chinese partner. Since joint ventures became feasible in China in the 1980s, many overseas companies chose their joint venture partners poorly. Ideally, multinationals should pair with local companies that explicitly share their strategic goals.

IP risks

There are a number of risks associated with conducting business in China. Miscommunication between partners, conflicting management styles and cultural differences are just a few of the potential flashpoints which could arise during the course of a joint venture.

Furthermore, given the importance attached to intellectual property in today’s business world, it is vital that foreign investors take adequate steps to protect their IP from appropriation. This is particularly important given China’s ‘first-to-file’ approach to IP management. Drafting a joint venture agreement anywhere is a difficult and potentially problematic process – and that is very much the case in China.  For parties looking to enter the Chinese market, it is essential that they keep in mind the relative immaturity of the Chinese economy; not only are private businesses a fairly recent development, the country’s legal system is still underdeveloped compared to mature markets in the west. Organisations embarking on a joint venture in China, irrespective of the industry, should develop their own clear and well defined contracts, amended and adapted to account for commercial practices in China, as well as its legal landscape. They must utilise legal advice, both domestic and Chinese, to protect their interests. Moreover, foreign partners must ensure that their objectives are continually aligned with those of their Chinese partner.

When drafting their joint venture agreement, parties should ensure that there is a clear and workable agreement governing the JV structure, with management roles plainly defined. Aligning management structures inside the framework of the JV will help to create a unified culture for the operation. This can assist both parties to the agreement to stay onside and work within defined parameters. Care must be taken, however, to tailor the joint venture processes to the local context, to avoid running afoul of local rules and regulations.

China can be a double edged sword. In many respects, the country is an attractive proposition for investors and acquirers, yet misjudging the landscape can be disastrous for an outsider. Firms choosing to partner with a local firm in a joint venture can get a competitive advantage, but determining who your partner should be is a task which must not be taken lightly.

© Financier Worldwide

BY

Richard Summerfield