China: Open for business (part I)

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"Expanding into China" is one of the easiest ways to explain to investors how your company will deliver on its growth targets this year and next. That expansion opens up a myriad of choices, including the type of vehicle used to enter China – a representative office; a joint-venture; or a wholly owned foreign enterprise – and the choice of advisors and partners used to enter the market. The first step most companies take is to talk to China experts in either the public or private sectors, but all experts were not created equal and the old axiom, "You get what you pay for," holds true in China as much as it does in Australia.

 

Picking the right partners and advisors to use when you enter China is crucial. However, for any company that has the luxury of time and or budget, the best way to enter China is to get the lay of the land first and the only way you can really do that is by being there. I asked Ashley Liu the CEO of animation firm Mindwalk Studios Inc. which one of her service providers (accountant, lawyer, research firm, or others) is the most valuable for her Beijing based firm.

 

“I would probably say that my accountant is the best service provider that I have right now, not because the accounting function is the most important or needed for the business, but rather because I have a great accountant. My accountant is a guy I met through Tsinghua Science Park who helped me register my company. He is a 30 year veteran in keeping books in China; a diligent and persistent individual who can put together excellent books and take on the various bureaus if anything needs to be done. But he is just an individual, not a well known firm. There are great individual service providers who can offer excellent services at extraordinary low costs. You don’t necessary have to go to a firm – it is more luck of the draw in China.” 

 

Liu might call it "luck of the draw", but before the former Nortel sales ace set up Mindwalk Studios with former colleague Michael Gagnon, she and Gagnon spent two years in Beijing, consulting to Chinese start-ups and generally getting the lay of the land. Most companies simply can’t afford that kind of time, but investing in getting to know the market before officially opening China operations reduces the risk of becoming the next China sob story.

 

Over the past three years I have had the good fortune of setting up a business in Shanghai and working with a number of institutional investors making their own entries into China. The one piece of advice I can give is to allow for delays. Everything, from setting up a company to hiring local staff, takes longer than it should.

 

The lesson learned by my most successful institutional investor client was that having real numbers gives a better perspective on industries than high-level market research reports and government statistics. According to my client, the best money he spent in China was a small personal investment in a company. As an investor he gets access to the company’s raw information, including accounts, latest notices from regulators and rumours about movement in the industry (online computer games, in his case) – this means he has visibility when it comes to investing in public companies. Australia’s Commonwealth Bank appears to be using this approach with its China entry, having bought stakes in regional banks Hangzhou City Commercial and Jinan City Commercial. CBA is also investing in some senior people to manage those investments.

 

While most companies view lawyers as a necessary evil (at best), their advice on structuring China entities is invaluable, especially given China’s relatively immature regulatory environment. Many industries have been opened up to foreign companies on the mainland, but a decent lawyer will be able to advise you on whether a particular industry is truly open (for example, retail) or only open in theory (print media distribution).

 

"Your most important first contact in China is probably your lawyer, accountant or market-entry consultant. A good law firm or consulting firm will typically provide you with much broader advice than just legal or accountancy matters, and will typically be able to make introductions for you to other service providers in China," says Walker Wallace, a Shanghai partner with New York-based law firm O’Melveny & Myers LLP. "Avoid anyone who tells you that they can get things done because they have "guanxi" (relationships). This is almost always a red flag, and truly competent people in China are not just selling themselves because of their contacts anymore. On the other hand, a lot of fraudsters are."

 

Firms like O’Melveny & Myers that have represented foreign and local clients are useful in that they understand motivations on both sides. Many companies entering China are exasperated by the fact that a commercial opportunity is staring the Chinese party in the face but they are still hesitant to act. The hesitation is often driven by a public servant’s desire not to make mistakes rather than a business person’s profit motive. State-owned enterprises still dominate China’s economy and Australian businesses entering partnerships with SOEs need to keep in mind that their partner might be more interested in keeping his pension than improving their bottom line.

 

Most big Australian law firms have a presence in Beijing or Shanghai. However, they tend to run them as satellite offices, using Hong Kong as the major regional base. In engaging a law firm to help structure China entities, Australian companies should insist on speaking to the associate who will complete most of the work in addition to the partner or senior associate who is the point of contact. Even junior lawyers with a couple of years experience can demand salaries that would make an investment banker blush, because of the economic boom China is experiencing. Turnover in the industry is high and junior associates often end up driving complex transactions and structures with little oversight from partners.

 

Another danger in engaging lawyers is that they often have no experience in certain aspects of Chinese law, because the laws are still being written. In broadcast media, video games and telecommunications, laws are being written as the market develops, and all the advice in the world will not help if the advisors do not know which way the law is going to go on an issue. In such cases, government relationships can be important. Firms like TransAsia Lawyers, founded by Australian Jesse Chang, are often consulted by Chinese government bodies in the process of developing regulatory frameworks for emerging industries. Because they participate in the development of regulations, these firms can offer insights not available from big name firms.

 

"Depending on what you do, all partners are important,” says Andrew Qian, a former lawyer, and now managing director of Shanghai-based boutique investment bank New Access. “If your company is big, then government support is indispensable. But the most important thing is to choose the right business partner."

 

Despite China’s legal industry suffering from high churn, law firms can take a lot of the pain out of running a China entity. Many law firms will conduct company secretarial work on behalf of their clients, making all necessary filings to the various municipal, provincial and state authorities. While Australian firms are no strangers to filing government paperwork, China’s bureaucracy is infamous. "Businesses that haven’t been shock tested by a proper China lawyer tend to encounter blow outs before too long," says one old China hand.

While the number of firms willing to bill for China-entry advice in China or Australia has swelled, not many will work with the firm in Australia and China. Seasoned consultants realise that a successful market entry takes work on the planning, and especially the execution.

"Too many successful Western companies believe that China will behave like other markets and, therefore, it is just a matter of segmentation, channel selection, and off you go. Those companies are generally encouraged by their Chinese advisors, who recognise the naive approach and just say, “Yes, that is good,” without explaining the nuances of the local market that inevitably rear up as the real stumbling block to market entry success. The “newboy” is left wondering why, in the face of such encouraging local feedback on their plans, success remains elusive," John Craven, managing director of Melbourne-based terranovate Group Pty. Ltd.

"The starting point is to recognise that China’s needs are uniquely shaped by geography, market scale, growth dynamics and history. These create unique opportunities, which require unique approaches. If this recognised and established as the base, the other technical items – like legal, accounting, finance and so on – are relatively straight forward because the business will be fundamentally sound. If not, then no amount of technical advice will save a flawed business plan," says Craven.

All of the "big four" accounting firms (Ersnt &Young, PriceWaterhouseCoopers, Deloittes, and KPMG) have booming practices in China, as do the big strategy consulting firms AT Kearney, McKinsey & Co., and Bain & Co. The same problems that plague law firms plague these big name service providers: high churn and high demand. All of these companies provide comprehensive services to firms entering China, but like law firms, the price is high.

Before engaging these firms, aspiring China entrants should look at resources that are available to them free of charge. AusTrade, Vic Export in Victoria, NSW Exporters Network in New South Wales, the New Exporter Developer Program in Queensland, and the International Trade and Investment Offices in Western Australia, offer some support for Australian companies pushing into China. Like the Commonwealth Bank, the WA International Trade and Investment Office has picked Hangzhou as one of its first China locations. Hangzhou boasts a population of 4 million, some of China’s top schools, and is only two hours by rail or road from Shanghai.

 

Hong Kong technically went back into China’s hands in 1997. However, under the "one country two systems" policy adopted by Beijing, Hong Kong operates much as it did before the handover. With Hong Kong and the P.R. China signing the Closer Economic Partnership Agreement (CEPA) in 2003, Hong Kong companies enjoy access into some industries not available to other foreign investors (film and television are one example). More importantly for Australian companies, the law that governs companies in Hong Kong is based on common law introduced by the British.

Setting up in Hong Kong means that a company has easy access to China’s most affluent province, Guangdong. Telecommunications and transport infrastructure on Hong Kong island also make it an easy, if expensive, place to work from.

The trade off is that companies basing themselves out of Hong Kong don’t get to know the market as well as their competitors who commit to mainland operations.

 

If ever there was a market where everyone has had a different experience, China is it. The easiest way to avoid falling into traps that others have fallen into before you is to talk to those have fallen into them. Don’t just listen to one advisor, get opinions from as many people as you can afford to and weigh their advice carefully. And finally, don’t fall into the trap of allowing for cultural differences. If something feels off, it probably is. If someone says, “That’s how we do things in China,” you can be pretty sure you are about to be screwed.