A China Joint Venture Success Story (Part III). Where To Go Now?

Today I bring you the third part of “A China joint venture success story”, an anonymous guest post by somebody who has been a partner in a joint venture in the manufacturing sector in China for over ten years. Make sure you do not miss the first and second part. You may read them in the links below:
A China joint venture success story (part I)
A China joint venture success story (part II). The lessons I have learnt.

Today´s post will describe this JV´s new situation. After more than 10 years of successful operation, key aspects of the relationship change: different players, different capabilities and new decisions to be made. Let´s read about it.

A Joint Venture Success Story (Part III). Where To Go Now?

We have had an excellent relationship over the past 11 years as we have been very profitable and able to sort out our differences amicably (and there have been some big differences), and accepted each other’s foibles. But the one thing we have not been able to do is to get the JV to change to meet the new and different market realities.
Our GM moved up the ladder some five years ago, as a bright and competent leader should, but he could not break the unspoken rule of the SOE (State-owned enterprises)  and find a replacement for himself outside the organization, even on our insistence.
We ended up with the accountant running the operation. Although managerially able, she has no commercial sense and we are suffering. We therefore will continue with the JV as long as it works for us but have already started up our own plant elsewhere in the same area. I understand, having spoken to a lot of people about our experience, that this is the normal cycle for JV’s and that eventually one partner outgrows the other and the “joint” goes out of the “venture”. We have reached this stage but it was great while it lasted.

 

What do you think? Is this the expected life cycle for a China joint venture?

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If you are interested in this topic you may also want to read the following article:

A China Joint Venture Survival Guide. 22 Facts and Practical Tips

A China Joint Venture Success Story (Part II)

Today I bring you the second part of “A China joint venture success story”, an anonymous guest post by somebody who has been a partner in a joint venture in the manufacturing sector in China for over ten years. Make sure you do not miss the first part. You can read it here.

 A China Joint Venture Success Story (Part II)- The Lessons I Have Learnt

Over the past 12 years of dealing with the Chinese,  I have learned three lessons which have been very useful to me.

 1. “When in China, do as the Chinese do”
The first is the BIG cross cultural issue of “when in China, do as the Chinese do”….even though it is inefficient, ineffective and sometimes humiliating for the person performing the task. It took a good 5 years for me to accept that I must only look at the result and not how it was arrived at, of any request I make; as trying to prescribe a given method invariably ended in failure and frustration for both parties.  The Chinese are particularly inclined to follow the known path and have learned, after millennia of having their heads cut off for straying from it, that it is the safe route.  This is particularly true in a JV where you really have little power to influence the day to day unless you have tremendous resources and patience to expend in imposing “your way”. We were lucky that we had been preceded (as customers) by large Japanese companies who had set up the control systems  and thoroughly trained the production  and quality staff in the making of their transformers.The  manufacturing methods therefore were already excellent when we arrived on the scene. But heaven forbid we try and change any of these methods!! So as long as the end product is good, you don’t need to know how they made it. But then lesson 2 applies.

2. Chinese culture is about form over function
The second lesson was to realize that the Chinese culture is about form over function. Probably the best example of this trait is the tradition of gift giving. If you are a frequent visitor to China you invariably end up with a trunk full of trinkets. You would expect this to stop or at least to receive different gifts when you visit the same company many times. But no, you will continue to receive the same framed Beijing Opera masks or tea sets you got last year and the year before that. No one asks you what you would like or find useful. Gift giving is a form that must be fulfilled whether the recipient likes the gift or not.   This principle of form over function applies everywhere so you must be very specific as to the end result you want or you will get what I call “ token outcomes” that meet the request but not the spirit of what you are looking for. This is particularly important to be aware of in quality control where a product can pass all the functional electrical tests you specify but no one on the line will fail the product for an obvious mechanical fault that was not on the list.  This is how Mattel gets lead in the paint used on its toys and melamine ends up in milk powder. You must make your functional expectations abundantly clear in a detailed fashion or you will get very creative surprises from people with generally the best intentions.

3. Some people will stay in the organization forever no matter how incompetent they are
You must accept that the people that are part of the organization when you start your relationship will probably be there forever no matter how incompetent they might be. Because of the Chinese habit of job changing (mainly in the younger generation), in the psyche of Chinese management, anyone who comes to work every day is worth keeping. The other reason, of course, is that many employees have some sort of political or economic connection with the company which makes them unmoveable. Their uncle may be the local tax collector or a sister is the secretary to the Chairman of the company.  My experience is coloured by that fact that our partner is an SOE and I understand that this phenomenon is particularly bad in this type of organization, but I have also seen it in private companies too. So if your engineering manager is a moron and your partner accepts that as fact, you cannot automatically expect him/her to be replaced. If you are lucky he may get a very competent assistant.

4. Listen to the “view from the other side”
A final thought is that our Head Engineer, in our home country headquarter, played a very large role in making this relationship work as he truly had a foot in each culture and understood the assumptions and frustrations each side brought to the table.  He was always able to offer me the “view from the other side”to  consider  before making up my own mind. This was invaluable as it  gave me perspective to work things out in an acceptable manner to both sides. A diplomat in your organization is a good investment when going to China.

What is your experience?

Coming soon: “A Joint Venture Success Story (Part III)- Where To Go Now?

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A China Joint Venture Success Story (Part I)

A few months back I wrote a series of posts entitled “A China Joint Venture Survival Guide”. It was based on the story of a joint venture that had gone very wrong (you can read it here). As soon as I finished the articles, I started looking for a joint venture success story, and I soon found it amongst my readers. Today I start a series entitled “A Joint Venture Success Story”, for which I´ve only written this introduction. This is an anonymous guest post by somebody who owns a Chinese Joint Venture, and although he wants to keep his company identity anonymous he has been very generous devoting time to these articles. In these posts he shares the lessons he has learnt during his eleven years of Chinese joint venture experience. This is a story very worth reading.

 A CHINA JOINT VENTURE SUCCESS STORY

We are a custom electronic transformer manufacturer with 26 years in the business and 32 employees in our home country,  of which 18 are involved in manufacturing our low volume and highly specialized products in house (while our JV in China produces the higher volume product).  China represents 20% of our turnover and we supply to contract manufacturers.

We currently have a joint venture with a medium sized SOE where we own 35% of the shares in the company and hold one seat on the Board of three people. The joint venture company has 250 full time staff plus another 150 contract workers. Our partner is an SOE Group of 20  companies all in the electronics sector. The Group has been in the business for over 50 years and our specific company within it started making transformers and inductors for Japanese companies back in the early 1980’s.  Basically we bought into a going concern, not a start up.

Why Did Our China Experience Start?

Custom transformer manufacturing is a labour intensive process and for that reason we decided to go to China in 1999 to find a manufacturing company we could work with. Our Head Engineer was Chinese and had seen the need,  well before Management woke up to the fact,  that we were losing the competitive fight in our home market to international distributors who were already sourcing out of Asia. 

How Did We Choose Our Supplier?

At that stage we tried to draw up a list of characteristics a Chinese company would have to have in order to be able to work with us but  in the end we settled on only one:
they would have to be truthful at all times.

We then did the usual quoting, sample orders, quality checks, etc. with five possible companies and we stuck with the one which did what it said it would do, our current JV partner.

From Supplier to Joint Venture Partner

We traded for over  18 months and this gave us both  the opportunity to get to know each other as individuals and as organizations. The trust that quickly developed between our operations can be credited to my opposite number who is one of the most forthright persons I know. He had started on the production floor and risen through the ranks, through sheer ability, to become the GM. Even though he is 15 years my junior, we  developed a very close personal bond, also shared by our Head Engineer,  which permeated the whole commercial relationship. We were very lucky!

In 2000 the GM came to us with the proposal of our buying into his company to form a joint venture (JV). It meant  good tax benefits for the operation as a whole and we understood that he was looking for the prestige within the SOE Group and the technology transfer that such an arrangement would bring. We, on the other hand, had not even contemplated a JV option, but having traded with Chinese companies for two years, we had learned that you are generally given service and pricing proportional to the amount of business you bring to the table. For us the JV presented the opportunity to sit at the table and therefore insure most of our requirements were met regardless of volume while we built the business up. The due diligence and subsequent value negotiations were very easy because of the tight personal and organizational relationship previously developed and by January 2001 we were partners.

Coming soon “A China Joint Venture Success Story (part II)

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A Joint Venture Survival Guide. 22 Facts and 22 Practical Tips- (3 posts compiled)

The following post compiles the complete “A Joint Venture Survival Guide” series. I´ve compiled it to help sharebility & bookmarking. If you had not read them before, I recommend it as it has got really good reviews. I hope you find it  useful.

Joint Ventures (J-V) in China can go well, and can also go very wrong. When the latter is the case, problems come up from where you less expect them. “Mike Smith” (not his real name) spent two years in rural China supervising his employer’s interest in a Chinese joint venture where they were the majority partner (deal signed before he landed there). His case falls within the second category I’ve mentioned (I would in fact say that all that could go wrong went wrong) but that has given him invaluable lessons on how to ensure things are done right. He has also met on the way a number of joint-ventures facing quite similar challenges to the ones he experienced.

We met to talk about his time representing the foreign partner and I’ve drafted “A Joint-Venture Survival Guide” based on his experiences, opinions, tips and comments (which means some of these tips will only apply only to manufacturing joint-ventures). 

Some introductory thoughts

1. China is a noble and good society… but when it comes to doing business, the value system changes. Ripping off a foreigner may be seen as a clever thing rather than a bad one.

2. Beijing, Shanghai and Guangzhou are in a universe of their own. Drive just 100 km away into central China and reality changes. It is a hardship environment and corruption is readily encountered.

3. You may have successfully set up joint-ventures and businesses in other countries. Do not assume China is going to be the same. You are lost without an expert if you are going to deal with a local partner.
“My company had successfully set up J-Vs across the world, and nowhere did they face the situations they faced here. They assumed they knew it all, and that was a big mistake”.

The Essentials”
4. The foundations for your success will be laid before you sign the deal.
Preliminary work is essential, and I cannot stress this enough. Once you have signed you are helpless. And later on, once your million dollars are in China, you will not be able to get them out unless you exit the J-V. There is plenty of room for disaster so make sure you dig into every single hole to figure out where the problems may be.
! Tip: This is the time to get as much information as you need. You need to be able to access all books, information about operational manual, … You may hear the somewhat overused sentence “What is the problem? Don´t you trust me?”. Well it is not about trust, it is about business, and companies that have nothing to hide will share the information with you. 

5.Confidentiality and know-how protection will be difficult in a small cities. All the legal issues about this will be judged in the city in which it happens, which means that if you have a company in Shanghai and someone “copies” your product in Ningxia, the legal procedure will be carried out in Ningxia so you will be dealing with all the difficulties of operating in a place that is not a j-v business hub.
! Tip: We are a European SME. If that is also your case you canhave free brief advice from the European Chambers of Commerce. Also a free advice for intellectual property, copy right, etc in China IPR SME Helpdesk

6. A GOOD consultant/advisor: Priceless.
You need real in-depth expertise to pull this one off successfully:
! Tip: “J-V conflict resolution and dissolution in China is really complicated compared to other countries. Consultant/Advisor companies have an instinct for knowing the real situation” 

7.[On consultants] … But find the one suited to your size
“The reality on the ground for SMEs is quite different to that of MNCs. We don’t have their leverage and muscle power and we deal with different issues/situations. It is essential to get on board a very good consultant but I wouldn’t recommend one of the big ones. I think they are better suited for big companies.”
! Tip: MNCs are often interested in high tech, setting up R + D centres, the pharmaceutical industry, medical issues and they will find some decent protection from the Local Government. In the case of SMEs that do business outside big business hubs, protection will be very difficult to guarantee and there will be unimaginable issues unless they hire the right consultant/advisor. And believe me, consultant/advisor big names will not help you to find the back door of your J-V.

8. Sign the right “pre-nup”
You obviously don’t want your relationship to go wrong, but if things happen you need to have put in place the right “break-up” conditions.
! Tip: Always use the Chinese or Hong Kong Arbitration Court. Most companies feel more comfortable with international arbitration, but what do you do when your Chinese partner doesn’t show up or doesn’t comply with the resolution? It needs to be done in China or Hong Kong where the resolution will be mandatory and enforceable.

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 J-V. 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. 

16. Money Hole #1: Company employees & Social Security.
There are a couple of “black holes” that are often used to suck your money away: the stated number of employees in the company and the payments to social security. You need to get two proofs here:
– Proof of the total number of employees in the company
– Proof that they are paying Social Security for
those employees.
Do not accept their word for this.
E
xperience: Our partner kept swearing that the company had 74 employees. My calculation was that there were no more than 50 employees in the company. I asked them to prove their claim but there were no contracts to be seen. When I asked for the bank transactions to assess the amount of money we were investing in overheads I was told it was paid in cash. When I asked for the receipts signed by the employees they said there were none.
I was not alone in this situation. I encountered other companies facing exactly the same challenge.
! Tip: You need to check this when you are negotiating and you still have bargaining power. If you discover this when you have already invested several million dollars you will be helpless. Do not accept their word on this. In China they file Social Security online. They have a website where they can access, through their company name and password, all their social security, accounting and fiscal (tax) data. Request to have access to this while still negotiating.

17. Money Holes #2: Stock Control
Companies often do not have good stock control in place and this is another big “black hole” your money will slip through.
Experience: You are told they bought 10 units of a product and they just purchased 5. When you try to investigate in detail they tell you there are not stock control systems in place, or the switch off the computer, or they tell you it does not work …
! Tip: Make sure you have access to all the policies and procedures manuals before you sign a deal. And once you have access, make sure you assess whether the policies and procedures are really happening or not. It is also quite possible that they do not even exist
The people from the purchase department should be “your people”. If that does not sound possible it is better to create the department from scratch and hire a local purchase manager of your choice, that you can trust, to ensure proper control.

18. Money Hole #3: Accounting
How many accounting books is your partner keeping? Make sure you keep a tight accounting process.

Experience: I always used to work late. One evening I happened to walk through the accounting department and somebody had forgotten to lock away the accounting books. To my surprise, the number of accounting books was higher than what I thought our company was keeping. I did not need to be too smart to figure out what was happening. Our partner was using fake purchase orders to divert money into his own personal accounts. Our accounting team was also keeping the books for his own company, which by the way was not supposed to exist any longer but should have merged into the J-V.
! Tip: Make sure you have unrestricted access to all cabinets and locations where information is stored.
!
!Tip: Keep a very strict monitoring of the accounting. All expenses must come with proof of purchase,authorised and signed by you or your team.Fa piao (we could translatefa piao as “super-receipts – receipts that are hand-stamped and recognised for tax and other purposes)”
are difficult to audit as they usually come without a description of the expense.
!!!Tip: Develop a good relationship with the CFO
!!!!Tip: Purchases should come with double signature (CFO and your representative) on set days (probably not necessary more than three times a week as purchases are planned in advance)

Other things that could go wrong
19. Technology Transfer – IP Risks
A fact you should be clear about is that your partner is likely to end up copying your technology.
Experience: Our target market was China, so our J-V was supposed to manufacture a product more sophisticated than the existing competition in China but not as technologically advanced as our products in Europe. In order to do that, we needed to transfer some know-how to our Chinese partner. I strongly suggested against it but at that time, it would have been equivalent to giving up the project and I still did not have physical evidence of what was going on.
My fears were soon proved right and I caught them copying our electronic cards … And later on I found out about them copying machinery and tooling.
!Tip: Well, you have no way to control it. Fingers crossed and good luck (do not forget we are talking “deep China” and not main business hubs). If all steps have been taken correctly things are more likely to go better.

Most business people I´ve met in China share a view that the new generation of Chinese business people who have studied abroad understand how to do business for the long term rather than for immediate and dishonest gain.

20. Company Seal- Always with You.
In China documents can be signed and stamped with the company seal. Back home contracts would not be valid unless you have signed them. Here the company seal is enough to make a contract valid … so
!Tip: Never leave your Legal Representative seal with somebody else. If you absolutely need to, be sure you can trust that person 100% as that seal is equivalent to your own signature.

21. Be ready to test your endurance
Experience: My Chinese partner was responsible for my house utilities. Once I was left without power for several days, another time I had no running water for three days. I also got internet connection discontinued.
People around me also suffered. I went through three finance managers who left the company shortly after I hired them. I remember the case of one of them who would systematically arrive at the canteen to be told there was no food for him. These are highly paid professionals who have no interest in going through that hell when they can have a nice well paid job somewhere else.
!Tip: I think when you have reached this stage, things are going really bad. In this case, it could be safest to control your house contract and utilities directly (probably through somebody you trust).

22. Beware of direct communication between your partner and your headquarters.
When you start proving to be a “damned nuisance” in your partner’s life he may try to get rid of you in different ways. He may contact your headquarters and try to make you look like inept or make them believe you complicate your life (and everybody else´s) with non-existent problems and issues.
Experience: In my case the Chinese partner kept calling my company’s president and emailing the board of directors in order to undermine their trust in me. I was very lucky because in the end I managed to get access to all sort of documents that proved we were being ripped off. But I’ve later on met other people who lost their positions due to pressure from the Chinese partner.
!Tip: Invest in “Educating your Headquarters” before you start operating in China. Headquarters don’t like to hear bad news. And some of the stories you will tell them are so unbelievable that they may end up thinking you have gone China-mad.

So what are your tips and experiences in Chinese joint ventures? You can leave a comment or contact me to share it in a longer form!

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A China Joint Venture Survival Guide. 22 Facts and 22 Practical Tips (III)

This is the third 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 posts you can read them here:
A China Joint-Venture Survival Guide (I)
A China Joint-Venture Survival Guide (II)

A Joint-Venture Survival Guide (III).(Tips 16-22)

“Watch Out for the Money Holes”
16. Money Hole #1: Company employees & Social Security.
There are a couple of “black holes” that are often used to suck your money away: the stated number of employees in the company and the payments to social security. You need to get two proofs here:
– Proof of the total number of employees in the company
– Proof that they are paying Social Security forthose employees.
Do not accept their word for this.
Experience: Our partner kept swearing that the company had 74 employees. My calculation was that there were no more than 50 employees in the company. I asked them to prove their claim but there were no contracts to be seen. When I asked for the bank transactions to assess the amount of money we were investing in overheads I was told it was paid in cash. When I asked for the receipts signed by the employees they said there were none.
I was not alone in this situation. I encountered other companies facing exactly the same challenge.
! Tip: You need to check this when you are negotiating and you still have bargaining power. If you discover this when you have already invested several million dollars you will be helpless. Do not accept their word on this. In China they file Social Security online. They have a website where they can access, through their company name and password, all their social security, accounting and fiscal (tax) data. Request to have access to this while still negotiating.

17. Money Holes #2: Stock Control
Companies often do not have good stock control in place and this is another big “black hole” your money will slip through.
Experience: You are told they bought 10 units of a product and they just purchased 5. When you try to investigate in detail they tell you there are not stock control systems in place, or the switch off the computer, or they tell you it does not work …
! Tip: Make sure you have access to all the policies and procedures manuals before you sign a deal. And once you have access, make sure you assess whether the policies and procedures are really happening or not. It is also quite possible that they do not even exist
The people from the purchase department should be “your people”. If that does not sound possible it is better to create the department from scratch and hire a local purchase manager of your choice, that you can trust, to ensure proper control.

18. Money Hole #3: Accounting
How many accounting books is your partner keeping? Make sure you keep a tight accounting process.
Experience: I always used to work late. One evening I happened to walk through the accounting department and somebody had forgotten to lock away the accounting books. To my surprise, the number of accounting books was higher than what I thought our company was keeping. I did not need to be too smart to figure out what was happening. Our partner was using fake purchase orders to divert money into his own personal accounts. Our accounting team was also keeping the books for his own company, which by the way was not supposed to exist any longer but should have merged into the J-V.
! Tip: Make sure you have unrestricted access to all cabinets and locations where information is stored.
!!Tip: Keep a very strict monitoring of the accounting. All expenses must come with proof of purchase,authorised and signed by you or your team.Fa piao (we could translatefa piao as “super-receipts – receipts that are hand-stamped and recognised for tax and other purposes) are difficult to audit as they usually come without a description of the expense.
!!!Tip: Develop a good relationship with the CFO
!!!!Tip: Purchases should come with double signature (CFO and your representative) on set days (probably not necessary more than three times a week as purchases are planned in advance)

Other things that could go wrong
19. Technology Transfer – IP Risks
A fact you should be clear about is that your partner is likely to end up copying your technology.
Experience: Our target market was China, so our J-V was supposed to manufacture a product more sophisticated than the existing competition in China but not as technologically advanced as our products in Europe. In order to do that, we needed to transfer some know-how to our Chinese partner. I strongly suggested against it but at that time, it would have been equivalent to giving up the project and I still did not have physical evidence of what was going on.
My fears were soon proved right and I caught them copying our electronic cards … And later on I found out about them copying machinery and tooling.
!Tip: Well, you have no way to control it. Fingers crossed and good luck (do not forget we are talking “deep China” and not main business hubs). If all steps have been taken correctly things are more likely to go better.
Most business people I´ve met in China share a view that the new generation of Chinese business people who have studied abroad understand how to do business for the long term rather than for immediate and dishonest gain.

20. Company Seal- Always with You.
In China documents can be signed and stamped with the company seal. Back home contracts would not be valid unless you have signed them. Here the company seal is enough to make a contract valid … so
!Tip: Never leave your Legal Representative seal with somebody else. If you absolutely need to, be sure you can trust that person 100% as that seal is equivalent to your own signature.

21. Be ready to test your endurance
Experience: My Chinese partner was responsible for my house utilities. Once I was left without power for several days, another time I had no running water for three days. I also got internet connection discontinued.
People around me also suffered. I went through three finance managers who left the company shortly after I hired them. I remember the case of one of them who would systematically arrive at the canteen to be told there was no food for him. These are highly paid professionals who have no interest in going through that hell when they can have a nice well paid job somewhere else.
!Tip: I think when you have reached this stage, things are going really bad. In this case, it could be safest to control your house contract and utilities directly (probably through somebody you trust).

22. Beware of direct communication between your partner and your headquarters.
When you start proving to be a “damned nuisance” in your partner’s life he may try to get rid of you in different ways. He may contact your headquarters and try to make you look like inept or make them believe you complicate your life (and everybody else´s) with non-existent problems and issues.
Experience: In my case the Chinese partner kept calling my company’s president and emailing the board of directors in order to undermine their trust in me. I was very lucky because in the end I managed to get access to all sort of documents that proved we were being ripped off. But I’ve later on met other people who lost their positions due to pressure from the Chinese partner.
!Tip: Invest in “Educating your Headquarters” before you start operating in China. Headquarters don’t like to hear bad news. And some of the stories you will tell them are so unbelievable that they may end up thinking you have gone China-mad.

So what are your tips and experiences in Chinese joint ventures? You can leave a comment or contact me to share it in a longer form!

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A China Joint Venture Survival Guide. 22 Facts and 22 Practical Tips (II)

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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Buying Out Your Chinese Supplier?

China Law Blog has published a post about foreign companies that try to buy out their Chinese suppliers. Dan Harris makes very enjoyable reading out of a very serious topic. You can read his post entitled here: “Buying A Chinese Company. Why China Deals Don´t Get Done

This is what you will learn from his article:
Very common practises for Chinese companies are:
-to under report employee wages to the government
-to underpay taxes
-to pay the rent under the table.
Which may be easy to get away with as a Chinese company but not as a WFOE.

So, if you are considering buying out your Chinese supplier, life will be a bit different for you. As a WFOE, your company will probably be wanting to play by the rules (and you better do it because as a foreign company you will be closely scrutinised) and the profits your supplier was making will be imposible to replicate as you will:
-end up paying double the amount your supplier was paying in wages and benefits
-pay all your income taxes
-have to increase booked rental costs

This is the short version. Read the original post here to get really interesting details and some cost estimates.

I will only add that it is indeed widely known that these practises are common. Some of these issues I will also mention in the second part of “A China Joint Venture Survival Guide” that is coming soon (Check my first post on the topic here)

Do you have any stories about buying out a Chinese company?

A China Joint Venture Survival Guide. 22 Facts and 22 Practical Tips.

Joint-Ventures (J-V) in China can go well, and can also go very wrong. When the latter is the case, problems come up from where you less expect them. “Mike Smith” (not his real name) spent two years in rural China supervising his employer’s interest in a Chinese joint venture where they were the majority partner (deal signed before he landed there). His case falls within the second category I’ve mentioned (I would in fact say that all that could go wrong went wrong) but that has given him invaluable lessons on how to ensure things are done right. He has also met on the way a number of joint-ventures facing quite similar challenges to the ones he experienced.

We met to talk about his time representing the foreign partner and I’ve drafted a series entitled “A Joint-Venture Survival Guide” composed of three posts based on his experiences, opinions, tips and comments .

A Joint-Venture Survival Guide (I).(First 8 Facts and 5 Tips)

Some introductory thoughts
1. China is a noble and good society… but when it comes to doing business, the value system changes. Ripping off a foreigner may be seen as a clever thing rather than a bad one.

2. Beijing, Shanghai and Guangzhou are in a universe of their own. Drive just 100 km away into central China and reality changes. It is a hardship environment and corruption is readily encountered.

3. You may have successfully set up joint-ventures and businesses in other countries. Do not assume China is going to be the same. You are lost without an expert if you are going to deal with a local partner.
“My company had successfully set up J-Vs across the world, and nowhere did they face the situations they faced here. They assumed they knew it all, and that was a big mistake”.

“The Essentials”
4. The foundations for your success will be laid before you sign the deal.
Preliminary work is essential, and I cannot stress this enough. Once you have signed you are helpless. And later on, once your million dollars are in China, you will not be able to get them out unless you exit the J-V. There is plenty of room for disaster so make sure you dig into every single hole to figure out where the problems may be.
! Tip: This is the time to get as much information as you need. You need to be able to access all books, information about operational manual, … You may hear the somewhat overused sentence “What is the problem? Don´t you trust me?”. Well it is not about trust, it is about business, and companies that have nothing to hide will share the information with you.

5.Confidentiality and know-how protection will be difficult in a small cities. All the legal issues about this will be judged in the city in which it happens, which means that if you have a company in Shanghai and someone “copies” your product in Ningxia, the legal procedure will be carried out in Ningxia so you will be dealing with all the difficulties of operating in a place that is not a business hub.
! Tip: We are a European SME. If that is also your case you canhave free brief advice from the European Chambers of Commerce. Also a free advice for intellectual property, copy right, etc in China IPR SME Helpdesk.

6. A GOOD consultant/advisor: Priceless.
You need real in-depth expertise to pull this one off successfully:
! Tip: “J-V conflict resolution and dissolution in China is really complicated compared to other countries. Consultant/Advisor companies have an instinct for knowing the real situation”

7.[On consultants] … But find the one suited to your size
“The reality on the ground for SMEs is quite different to that of MNCs. We don’t have their leverage and muscle power and we deal with different issues/situations. It is essential to get on board a very good consultant but I wouldn’t recommend one of the big ones. I think they are better suited for big companies.”
! Tip: MNCs are often interested in high tech, setting up R + D centres, the pharmaceutical industry, medical issues and they will find some decent protection from the Local Government. In the case of SMEs that do business outside big business hubs, protection will be very difficult to guarantee and there will be unimaginable issues unless they hire the right consultant/advisor. And believe me, consultant/advisor big names will not help you to find the back door of your J-V.

8. Sign the right “pre-nup”
You obviously don’t want your relationship to go wrong, but if things happen you need to have put in place the right “break-up” conditions.
! Tip: Always use the Chinese or Hong Kong Arbitration Court. Most companies feel more comfortable with international arbitration, but what do you do when your Chinese partner doesn’t show up or doesn’t comply with the resolution? It needs to be done in China or Hong Kong where the resolution will be mandatory and enforceable.

Coming soon “A Joint-Venture Survival Guide (II)” with more interesting and useful tips to help you navigate a J-V negotiation.

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Basic Steps to Form a WFOE in China

If you are considering to set up a Wholly Foreign Owned Entity (WFOE) in China, the China Law Blog has just published a very good post that takes you through the basic steps that you will need to follow to form this type of entity.

I think this is a good post to recommend because a lot of foreign entrepreneurs choose to form a WFOE to stablish their presence in China. WFOEs allow you to keep full control and ownership of the operation and it also makes IP protection easier -hence it has become the preferred vehicle to enter this market.

Bellow you can read a recap of the China Law Blog recommendations and steps (you can read the complete post here, and if you still don´t subscribe to their blog I highly recommend you to do it):

1. Make sure your business is legal for foreigners.

2. Provide the required documentation: proof of the company being a duly formed and validly existing corporation or Limited Liability company in its home country.

3. Investor Documents Needed:

a) articles of incorporation or equivalent

b) business license, both national and local

c) certificate of status or a notarized copy of the Corporate Register for the investor or similar document

d) bank letter attesting to the account status of the investor company

e) description of the investor’s business activities (in Chinese)

4. Consider forming a Special Purpose Company to own the WFOE. It is common to form a Hong Kong company for this purpose and there are often tax benefits.

5. Secure Chinese Government approval.(and they remind you that in China, approval of the project by the relevant government authority is an integral part of the company registration process and you risk not being able to register if the project is not approved) . 

6. Documents to be submitted in order to achieve Chinese Government approval:

a) articles of association (which will determine issues like stablishing directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital)…
Note from Foreign Entrepreneurs in China: you need to devote special care to this part. The articles of association are one of the most important set of documents you will be preparing. The articles of association include articles like “business scope” which needs to truly reflect any type fo activity you are planning, as you will not be able to operate out of its limits.

b) feasibility study (in Chinese).

c) a lease. ( an agreement for all required leases must be provided)

7. Other documents that you will be requested: proposed personnel salary and benefit budget. And any other documentation required for the specific business proposed.

8. Approval process: 2-5 months for governmental approval, depending on the location of the project and its size and scope.

And just to finalize this post I will remind you what most entrepreneurs tell me in their interviews: “Get good advisors”. The people who help you navigate the set up of your company in China can make a huge difference.

More recommended reading: Take a look to our post entitled “Setting Up a Representative Office in China: 10 Steps and some Practical Tips”. Although it was produced with R.O.s in mind, it still provides very good tips that apply to other type of entities.

Setting Up a Representative Office in China (III): Less Exemptions and More Taxes! The New Tax Treatment is here!

Considering setting up a Representative Office (R.O.) in China? You may need to revise your numbers.
The Notice from the State Administration for Industry and Commerce and the Ministry of Public Security “Further Strengthening the Administration on Registration of Resident Representative Offices of Foreign Enterprises” (Jan 4th, 2010)[1] is not the only cloud on your horizon. On February 20th 2010 the State Administration of Taxation (SAT) issued a circular announcing the new tax treatment for foreign R.O.s “Tentative Measures for the Administration of Taxation on Representative Offices of Foreign Enterprises” (Guoshuifa[2010] No.18 (Circular 18)) [2].

Two main changes are worth highlighting:

  1. Exemptions
    Local tax authorities are requested to review existing tax exemptions granted under the old rules.  Till now, R.O.s’ expenses related to activities like market research, liaison and other preparatory sales and manufacturing activities for their head offices products could enjoy tax exemptions. And it is believed that often R.O.s were getting exemptions even if their expenses did not fall into these categories.
    Under the new tax treatment, exemptions will only be applicable if there is a relevant tax treaty or agreement.
    … So, reassess your situation, and if you believe you still qualify apply a.s.a.p.
  2. Deemed profit rate increase from the current 10% to a minimum of 15% of the operating expenses (when using the cost-plus method/ for R.O.s that can accurately detail expenses)
    Deloitte has published in its China newsletter a very comprehensive analysis that shows that this change in the taxable income ratio will mean an increase in tax costs of no less than 24% (you can read the detailed analysis in the link at footnote # 2).
    And the most confusing part here is that this 15% that everybody is now hoping for is just “a minimum”. So one wonders how will the local tax authorities evaluate whether an R.O. ‘s profit should be deemed 15% or 50% …

These changes will definitely affect companies deciding or reassessing what legal entity best works for their China business. Ana Inchausti, from Inventta, also touched on that point when I approached her for my previous post on how SAIC’s new regulations would be affecting R.O.s. I quote bellow a summary of her comments on the tax changes:

“…To the question if we still consider R.O.s a practical approach to establish businesses in China, we would say yes, R.O.s are still an interesting approach but maybe to a more reduced group of projects than in the past. The tax increase is, in our opinion, the major change affecting the decision making process…We would advice our clients to set up a R.O when they are going to keep a small medium structure with low costs and just a few employees and overall if, after doing the math, to pay tax based on their expenses is still more interesting and competitive than to pay a profit based tax, as its compulsory to the WOFEs.”

These next two weeks are going to be very interesting. R.O.s will be submitting their quarterly EIT (Enterprise Income Tax) and BT (Business Tax) for the first time under the new regulations so there may be not-so-nice surprises. I’m planning to follow up with some R.O.s to find out what these changes have meant to them. Maybe it is time to go WFOE!

Would you like to share how the new regulations are affecting your R.O.?


[1] Link to the State Administration for Industry & Commerce of the People’s Republic of China. Notice of changes in Registration of Foreign Representative Offices – English reference translations:
http://202.108.90.68/nd/100108143617-0.htm

[2] Deloitte Tax Analysis on the new Tax Treatment issued by SAT “Tentative Measures for the Administration of Taxation on Representative Offices of Foreign Entreprises” (Guoshuifa[2010] No.18 (Circular 18))
http://www.deloitte.com/assets/Dcom-China/Local%20Assets/Documents/Services/Tax/TaxNewsletterEN2010/cn_tax_tap1012010eng_080310.pdf