This is the second post of the series entitled “A China Joint-Venture Survival Guide” based on Mike Smith´s experiences as his company’s representative in a Chinese joint venture. If you have not read our previous post with the first set of facts and tips you can read it here:
A China Joint-Venture Survival Guide (I).
A Joint Venture Survival Guide (II).(Tips 9-15)
“The Danger Zone”
9. Your Potential Partner is Well Connected … Maybe Good, Maybe Bad
Experience: It is quite common to be taken on the “big tour”, introduced to the city mayor, the bank’s president, and all sorts of top-end contacts. Your partner will put especial effort into making a great impression and showing you how easy doing business in China is going to be if you deal with him.
! Tip: Do not be dazzled by your partner’s connections …They will not necessarily be used for your benefit.
The fact that your partner is well connected is good (you obviously don’t want to end up with a nobody), but it is also a fact that at times those connections are only used for their own benefit.
10. Financial Reports: “I can’t live with or without you”
Financial reports: you need them, if only because when things go wrong you will be the first one fired if you did not order a financial report. But just be aware that reports can easily be falsified, and a lot of relevant information may be missing.
Experience: I will not get into too much detail but let’s say that I have even seen the falsifying process in action. Do not believe everything you read, and be aware that there will be facts/realities that are not reflected in those reports.
! Tip: There are things you will only get the feel for if you base yourself at your potential clients´ workplace. My recommendation would be to place your trusted person (who by the way should be China-knowledgeable and understand what he/she is looking for) at the company´s site . You need to see how the factory works, how many workers there are, their accounting, their stock control ….
11. Tax Planning: “Tax Breaks. Do not believe all you hear”.
While you are negotiating the joint venture you will be promised a lot of benefits. Tax breaks are a common tool to lure you into a location that needs to be developed. A lot of companies start operations in a location partly because they have been offered corporate income tax exemptions or reduced/zero import/export duties. It is also common to find that the day you to try to apply for them, you are told that the central government has changed the regulation and they can no longer grant you the benefits they promised.
Experience: We were promised tax exemptions on all those tools and parts required for our product manufacturing. It did not happen. Not even once.
! Tip: As mentioned in tip number 5 , it is essential to get the support of a good consultancy firm. Your investment should also make sense regardless of the tax exemptions or other promised benefits.
12. Let me guess: your Chinese partner wants to contribute the land to the joint venture.
Experience: The Chinese partner always wants to contribute his own properties to the joint venture. But, can he give you actual proof of the real land value? These are common situations to encounter:
- The real value of the land, does not correspond to what your partner is claiming.
- The audited value presented and paid by your Chinese partner has been (easily) falsified.
- All sorts of excuses to justify the absence of a purchase document stating the real value they paid: “Government does not give invoices. We got a good deal …” . Do not fall for them.
In our case, we got an independent valuation of the land. It was worth 30% less than what our partner claimed.
! Tip: Do not fall for excuses. A land purchase should be properly documented. Beware if is not.
Experience: We wanted to buy land for the JVC. Our Chinese partner finally presented what he deemed was the best possible location and the required size(we felt it was too big). The land value would be considered capital contribution by the partner. He presented an alleged Government document stating the land value. The document had no seal so we suspected something was wrong and requested an independent valuation. The land value estimation was 200,000 € cheaper than the value presented by our partner. Our company´s President trusted the partner so they decided to take his word on this (by that time MD was already suspicious about the partner). The land was purchased, the invoice was never seen. He showed us an ownership title and the land became his capital contribution. Later on I managed to located the real purchase documents and the deal had been sealed at a 400,000€ cheaper prize.
13. Does your land have a license to have a factory built on it?
You need to watch out for this one. Chinese companies often ignore this step. You may find sizeable companies operating (100 employees, tax bureau number, social security …) without the license to legally operate a factory/company on their land. That may not be a problem while you stay together (they will surely have their ways to ensure there are no problems). But in the event of a split you may face one of these two situations:
- You want to sell it but you can’t because there is no licence for the construction done.
- You want to operate it alone, but being a foreign company you will find the government inspection at your doorstep day one. And they will close it due to lack of permits.
! Tip: Make sure you know all the licenses the business needs to operate legally. If your partner claims to have the license for that land already, you need to see it. If licenses are pending have your expert/consultant involved in that matter.
14. Building the Factory- Oh Nightmare
This is another potential source of conflict. You will probably trust your partner to lead the factory construction works.
Experience: “…a workshop building would not progress and when I inquired I would get “We have run out of money”. Digging into the contracts details I would find a lot of irregularities like missing contracts, unsigned contracts …”
! Tip: “If your project involves building a factory, I would recommend to budget for 15% to 20% extra cost vs. agreed amounts. Timewise, I would build in an extra 40% as a buffer. Penalties should be included and quantified in your contract. And as mentioned before, always use the China or Hong Kong Arbitration Court”.
15. Check Company Operational Manuals.
Very often there is nothing written on how operations should function. When you land there and try to organise things you do not even know where to start. And what is worse, your Chinese partner is not interested in changing anything as he feels it has been working for him for years before you arrived.
! Tip: The trusted person I advise before to place in your prospective partner´s operation should check out the operational manuals and whether the company works in compliance with them. If there are no manuals in place, you should request them to record their existing processes so that you can discuss them and negotiate before the deal signature.
Coming soon the final post of this series: “A Joint Venture Survival Guide (III)”. More interesting and useful tips to help you navigate a joint venture negotiation.
Would you like to share your experience with a Chinese joint venture?
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