China invests in Europe – a five minute briefing for in-house teams at potential Western targets or partners
This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.
Chinese capital has hit the acquisition trail, throwing up big potential merger or divestment opportunities for European corporates seeking to partner with Chinese corporates or sell assets or businesses to them. But it also means major challenges as West and East meet in the boardroom or across the negotiating table.
In 2014, the volume of outbound deals by Chinese investors soared by more than 20% over the 2013 total. According to the FT, the rise in outbound investment over the past decade has been “meteoric; in 2002 Chinese investors spent just $2.7bn on acquisitions and greenfield projects abroad but by 2013, the total had increased 40-fold to $108bn.” Indeed, China is now a net exporter of capital. And of note for European businesses: despite the popular perception that outbound Chinese money focusses on natural resource acquisitions in Africa, Australia and Canada, Chinese investors are increasingly turning to developed markets, including Europe, in search of the advanced technologies and powerful international brands they lack at home. Despite a small decrease year-on-year from 2013 to 2014 (attributable by some analysts to the dampening effect of China’s anti-corruption campaign, which discouraged offshore deals thought to be a means of hiding assets out of reach of the PRC Government) the overall trend-line is robust.
This means expanding opportunities for Europe-based deals with Chinese corporates, but it also means formidable challenges arising from major differences between European and Chinese commercial perspectives and negotiating practices. Thinking clearly about these challenges can make them easier to manage and help prevent them from turning into stumbling blocks.
Goals and expectations
A common misconception is that Chinese investment is mainly focused on primary resources, advanced technology and fast channels to Western markets. It may therefore be surprising to learn that the Economist Intelligence Unit has reported that 82% of PRC executives who were sampled in fact cited the acquisition of “advanced management techniques” as one of their top drivers.
It may also be surprising to learn that many Chinese business people are aware of the typical concerns of Western partners about Chinese lack of transparency and potentially limited ability to participate effectively in the management and operations of Western businesses in which they invest (due to relative inexperience in the Western marketplace and the legacy of an economy which for many years was substantially State-directed). Chinese parties are also increasingly aware that these factors may create a “China price premium”, especially when it is a State-owned enterprise that is the potential acquirer.
Despite these and other elements of shared understanding, differences abound, and outweigh the similarities. Western and Chinese parties’ timeframes for recoupment of investment and generation of profits may vary widely, and need to be explored and discussed openly. Moreover, the Chinese side’s understanding of the complexities of European labour relations is certain to lag considerably behind the Western side’s familiarity with these issues, just as the converse will be the case when Western businesses undertake joint venturing or other forms of establishment in China. Similarly, a Chinese party is unlikely to have a sound grasp of the administrative and regulatory environment governing a host of issues across Europe, since its own experience of such issues will necessarily be very China-specific.
The Guanxi conundrum: “If I don't really know you, I can’t trust you…but if we don't trust each other, how do we get to know each other?”
Guanxi, properly understood, is a form of “social capital”, involving networks of mutual reliance and deep trust developed over time through the performance of reciprocal favours or services. Guanxi is not mere friendship or “connections”. You cannot develop guanxi through a couple of dinners and a few rounds of drinks, even when gifts have been exchanged and eternal friendship seems to have been sworn.
Chinese have learned, through many centuries of experience, that personal relationships are an essential element of dependable transactions. As a second best, one will rely on a relationship at one degree of separation, i.e. dealing with someone known to (and trusted by) someone you already know and trust. This poses a big problem for Chinese venturing out of their own country and guanxi circles. What can be done?
The important thing is for the Western side to understand that developing trust takes time, and until it is established, the Chinese side may be hesitant to provide disclosure about many key issues. This means starting with a full information exchange exercise, or the mutual provision of representations and warranties, may be the wrong approach and simply lead to frustration or later embarrassment. It helps if the Western side consciously sets out to establish a relationship based on trust, rather than starting with the exchange of products, services or payment. Don't rush. Which leads to the subject of time…
Time: everything seems to take so long!
Chinese parties’ decision-making is famously slow and seems to follow unpredictable pathways. They can sometimes be frustratingly dilatory in identifying targets, carrying out due diligence, gaining internal consensus, and procuring any requisite internal or regulatory approvals. Sometimes this means the Chinese side has lost genuine interest, but is hedging its bets. But at other times it means that the intention to consummate the transaction remains, but that something is blocking the way forward.
For the Western counter-party, the wisest course is to assume from the outset that unexplained slowdowns are simply going to happen. Chinese corporates often operate on the basis of more full consensus-seeking (both vertically and horizontally) than is the case with many Western corporates. Regulatory or even Party approvals processes – which remain unexplained to the Western side – can take a lot of time. Sometimes, no-one wants to make a decision.
Your Chinese counterpart may be forthcoming and explain the delays, but at other times may just appear to be dodging your questions. An unanticipated issue, too embarrassing to discuss, may have arisen. Don't be automatically alarmed or angry when things slow down; rather use this as an opportunity to deepen the relationship by sympathetically seeking to draw your counterparty out on the issues, and offering to assist through provision of supplemental information. You may be rebuffed, but your gesture may be appreciated.
Step by step
These issues carry certain ramifications for deal-making with Chinese parties. Here are 5 important points:
- The importance of relationships means that there is a preference on the part of Chinese parties for broad-principle agreements which affirm and build upon relationships and earlier discussions and agreed points, rather than quickly moving to the sort of highly detailed transactional documentation so familiar to businesses operating in the Anglo-American world. Since it takes time to secure internal consensus and to develop mutual understanding, familiarity and trust, it can be counter-productive to bombard the Chinese side in the early stages of negotiations with full deal documentation.
- Instead, a step-by-step approach can be more productive, best done through a series of successive iterations of MOUs or Letters of Intent. This won't preclude seeking legally-binding provisions from the outset, such as confidentiality, exclusivity or bearing of costs.
- The stress on relationships also means that Western parties should ensure that senior-level people, able to take decisions, should play a visible part in the transaction. It will be important to avoid mismatched levels of seniority at meetings and discussions and this will need to be discussed with the Chinese side in advance where necessary.
- Notwithstanding the importance of relationships, deals still need to be rigorously documented. In China the differentiation between law and Government/Party policy is still emerging. When the primacy of relationship-based “guanxi” business is added to the mix, the result can be inadequate attention by the Chinese side to the importance of detailed deal documentation. Nothing will be gained by having your counterparty enter into a deal it doesn't understand, only for the relationship to break down later as they come to understand what they have signed. Take time to make sure there is an understanding of the meaning of major contractual provisions, the importance of rigorous disclosure and verification, and (where relevant to the transaction) the role and responsibilities of directors in a Western company.
- Language differences can un-do apparent mutual understanding. For any serious discussion, the Western side will need its own interpreter. This is not going to offend the Chinese party, who typically will come to the table with its own interpreter. Rather, it will help avoid misinterpretations, reflecting a Chinese cultural proclivity to avoid or soften uncomfortable topics.
If you would like to discuss any of the issues covered in this article, please contact Olswang's China advisor Andrew Halper. A fluent Chinese speaker who spent 7 years in Beijing as a diplomat and lawyer, Andrew has over 20 years' experience advising Western corporates pursuing transactions and investments in the People's Republic of China, and Chinese companies pursuing business outside of China.
