Mistake #1 -Joint Ventures

Is creating a joint venture the right vehicle for a first time investor wanting to do business in China? Many people think having a local partner will help expedite the approval process, establish local connections and improve the chances of success of their business.

However, these “advantages” are either misleading or come with a significant price tag.

Talking about local connections in China, wouldn’t it be convenient to partner up with local government entities? Unfortunately this is usually not a smart idea. Because when things go sour (and they do all the time) you suddenly realize the last thing you want to do is to test the impartiality of a Chinese court by suing a Chinese governmental entity. If the relevant U.S. constitutional protections (e.g. the taking clause) come to your mind, you may be too naive to consider forming a joint venture with a Chinese government entity.

Furthermore, you should bear in mind that teaming up with a Chinese company (under the current Chinese foreign direct investment laws, the Chinese partner may not be an individual) means a lot of extra work (if not extra trouble) that otherwise may not be necessary.

First, it is highly advisable to do a background check of your potential Chinese partner. Although there are local credit agencies out there that can investigate and submit reports to you for under $1,000 you are advised to have a local law firm to do a comprehensive background investigation. At a minimum, you should check with the local Bureau of Industry and Commerce to determine if a Chinese company is duly registered with the bureau, its registered capital and who are its legal representatives.

Second, you and your potential Chinese partner should sign a joint venture contract (the “JVC”) and articles of association (the “AA”). The JVC and AA are the most important legal documents for determination of each party’s rights and obligations when a dispute arises you should also be aware of the fact that the Chinese version of the JVC and AA will prevail over the English version. Therefore, the documents should be carefully prepared or at least reviewed by a local attorney experienced in these matters. You should also know that the JVC and AA will be under the close scrutiny by the Chinese approval authorities before they have legal effect. This is to ensure the Chinese partner’s interests in the joint venture. Needless to say, preparing and agreeing on the provisions of the JVC and AA in both English and Chinese add to the already time consuming approval process. For more discussion regarding what should be included therein, please refer to our article on the JVC and AA.

Third, you should take measures (not just legal ones) to protect your IP rights from being infringed upon by your Chinese partner. Please check our IP Protection series for our suggestions of how to handle this issue.

Fourth, a joint venture’s decision making process is usually slower than in a wholly foreign owned enterprise. The Chinese government will ensure that the Chinese partner’s role in the joint venture’s corporate governance is not only reflected in the JVC/AA but also properly executed in every board meeting. In the meantime, playing boardroom politics with the local partner demands significant sophistication from an international investor.

Finally, you should be prepared for the clashes of corporate culture from management style, corporate ethics to community relations. To avoid disastrous consequences you have to overcome the cultural clashes, a task that also demands a high degree of sophistication.

You may need to consider a joint venture if the specific industry you are engaged in is restricted with only partial foreign investment permitted, or if the Chinese partner’s contribution of supply chain, existing customer base, or distribution channels is pivotal to your proposed entry or expansion into China.

In any case you should carefully weigh the pros and cons of a joint venture. If you do not feel you are up to this very real challenge you should avoid a joint venture.

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