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China’s Views On Investment. Think Communism.

Posted in China Business

By: Steve Dickinson

This post is part I of a two part series on why investing in Chinese companies can be so different than investing in Western companies.  In this first part, I address how the way Chinese companies typically view investment is so different from that in the West.  In Part two, I will talk about how this differing view so often impacts Chinese joint venture deals.

I often write and talk about how China’s lack of intellectual property protections stems in part for its contempt for the intangible. As an extension of this attitude, China also has what I would call a contempt for investment. For the Chinese, work is generally all that counts. Investment has no permanent value and it tends to be treated like a loan. Once the investment is repaid, the investor is expected to depart and allow the executives who run the company to receive all future rewards. Investors that insist on sticking around to earn a return on their investment are considered to be fundamentally dishonest. Since the investor is operating in bad faith, it is perfectly acceptable for the Chinese company owner to use extra-legal methods to get rid of the investor that overstays its welcome.

This attitude explains one reason why investment in Chinese companies is so difficult. Take the typical venture capital portfolio. The typical venture capital investor is not expecting that every investment will result in a substantial return. Instead, it hopes that one investment of many will score big, resulting in a pay-off that compensates for the relative failure of other investments in the portfolio.

It is difficult to make this approach work in China. The Chinese side is quite happy to accept venture investment in a project that fails. When the project fails, the investment is lost, but the effort of the founders is also lost. As far as the Chinese side is concerned, both sides lost the same amount and they feel no need to compensate the investor for its losses. In fact, the entrepreneur usually believes the loss of its time and effort is a much greater loss than the loss of the investor. After all, the investor only lost money, which can be replaced. The time and effort of a young entrepreneur cannot be replaced. This loss is therefore much more tragic that the mere loss of money.

On rare occasions, however, the project will work and the venture will succeed. In that setting, the entrepreneur founders will expect that the investor will be happy with receiving a return equal to its investment plus a small amount of profit roughly equivalent to the interest it would have earned on its money. When the founders learn that the investors intend to ride the project to the very end, reaping the majority of the financial benefit, the founders believe that they have been tricked. Their work is the entire value of the company. How can it be justified for the investor to stick around and reap the rewards when the investor has done no work? No one expects their banker to continue to demand payments after the loan has been repaid.  In fact, such a demand from a lender would be seen as fundamentally wrong. The same is often seen to apply to an investor. Since the investor’s continuing demand for payment seems fundamentally wrong, the founders will work to eject the investor in some way, even if this is actually damaging to the company. The fact that this attitude is completely contrary to current Chinese law is irrelevant. The attitude is deep-seated and seems to pre-empt any consideration of what is provided for in China’s legal system.

This attitude makes private equity difficult to do in China. I am often challenged when I say there really is no domestic private equity in China. Critics point out the large number of funds that are called “private equity funds” that operate all over China. However, when examined, these funds seldom resemble what we call private equity in the United States. The Chinese funds are more like what we would call “short money lenders.” They lend to a project at high rates of interest. They take their capital and interest and then leave. They usually do not attempt to enter into any kind of a long-term arrangement with their investment targets. This is because they fully understand the basic principal: loans are acceptable, even at high rates of interest. Equity investment is not. Work counts, but investment does not. Think communism.

What are you seeing out there?

  • Natalyia

    This is interesting. I never thought about it, but I found me agreeing with the Chinese way in this article. Of cause, I am a Chinese.

    Just one thing: this article makes NO analysis on how this Chinese way is related to communism, however, it puts “communism” in the title. I didn’t get the logic. BTW, as a native Chinese, I have to say that it is the traditional culture (such as Confucianism), not communism, that plays a role in most of the “Chinese” things. In this case of investment, the long-time respect to diligent work seems to be much better an answer. Think “no pain, no gain.” The traditional culture has been in every Chinese’ blood for thousands of years. Its influence is much greater than communism, which existed in China for only decades and is now fading. Stop the stereotype.

    Could you explain more about the western people’s view on investment? Thanks.

  • maofucious

    Money is cheap in China, because of financial repression. There’s noplace else to put your money…so why not my company?

    I agree a bit with Natalyia, that Communism isn’t exactly the right description. I think more of the Art of War, and the importance of location. The far-away owners’ rights are always going to be subservient to those who are closer to the company.

  • twofish

    Long term capital is extremely cheap in China because you have people with tons of money in cash, but no where to put it. Short term working capital is extremely scare, and that’s where people make large amounts of money.

    Also investment in Chinese companies is not particularly difficult. The issue for foreigners is that a lot of the opportunities are off limits, both in theory and in practice. There is a lot of semi-legal shadow banking going on in China.

  • twofish

    Some else is that if you end up with people screaming at each other at the end of the JV, it’s likely that there was a lack of communication at the beginning of it. Part of the reason things are likely to go bad, is that’s not that difficult to get capital in China, and had the Chinese side known that the foreign investor was planning to take most of the profits, then they could have likely gotten other financing or maybe even just let the company go under.

  • Ron Miller

    All of this underscores that China has a long way to go. They need to open up more and I don’t think the new leadership intends to take them in that direction.