As regular readers know, both my co-blogger (Steve Dickinson) and I have written extensively on China Joint Ventures, both here and elsewhere. This is because we find them fascinating, mostly because they are so difficult to make work. Here are some of our previous writings on joint ventures in China that focus on when to enter into a joint venture and how to make one work:

What distinguishes the joint ventures that work from those that don’t?

According to a recent McKinsey article, Avoiding blind spots in your next joint venture, “even joint ventures developed using familiar best practices can fail without cross-process discipline in planning and implementation.” According to McKinsey’s own studies, JVs succeed only around half the time, even though JV best practices are well known:

When we interviewed senior JV practitioners in 20 S&P 100 companies—with combined experience evaluating or managing more than 250 JVs—they estimated that as many as 40 to 60 percent of their completed JVs have underperformed or failed outright. Further analysis confirmed that even companies with many joint ventures struggle, even though best practices are well-known and haven’t changed for decades. In fact, most of our interviewees endorsed several that have long been the gold standard for JV planning and implementation: a clear business rationale with strong internal alignment, careful selection of partners, balanced and equitable structure, forethought regarding exit contingencies, and strong governance and decision processes.

Why do so many joint ventures fail even when the Western company knows what it should be doing to make it succeed? Mostly a failure to follow best practices either initially or later on down the road when the company’s enthusiasm for the joint venture has waned:

Our interviewees suggest that in the rush to completion, even experienced JV managers often marginalize best practices or skip steps. In many cases, the process lacks discipline, both in end-to-end continuity and in the transitions between the five stages of development—designing the business case and internal alignment, developing the business model and structure, negotiating deal terms, designing the operating model and launch, and overseeing ongoing operations. Moreover, parent-executive involvement often declines in the later stages. Finally, many JVs struggle with insufficient planning to respond to eventual changes in risk. Such lapses, even in the early stages of planning, create blind spots that affect subsequent stages and eventually hinder implementation and ongoing operations. We’ll examine each of these issues, along with the approaches some companies are taking to deal with them.

The “rush to completion” is usually due to pressures to “get the deal done quickly.”  How can this be remedied?  “Companies must find ways to balance the pressure for speed with the demands of planning a healthy joint venture—especially allocating their time and resources in line with the potential for value and impact.”

I tend to agree.

If I look back at the China joint venture deals in which my law firm has been involved (and lets throw in the Russian joint ventures and the Vietnam joint ventures that we have drafted as well because why not?), I would say that there is a direct correlation between the time and planning and even difficulty of reaching a joint venture deal and the eventual success of the joint venture.  Put simply, the joint venture deals that were completed in one month are less likely to be standing today than those that took three months.

Why is that?

Joint ventures are incredibly complicated. Just by way of one simple example, who is going to be in charge of hiring, you the American company or the Chinese company? The quick answer is usually the Chinese company, because the Chinese company certainly knows better who to hire in Dalian or in Wuhan than you do. But then what’s to stop the Chinese company from hiring 100 of its relatives or from charging mediocre people for jobs at your joint venture? And if it does that, where do you think all of your profits are going to go? So now that you realize the importance of your having some say in hiring, what say are you going to require? Certainly you do not want to do the hiring, but do you want veto rights? Should you be limited in the number of potential employees that you have the right to decline? What about firing employees? Certainly your position will be different on managers than janitors. Speaking of janitors, are you going to want to limit the number of janitors the JV can hire? The issues on control can be endless, and this is just one of thousands of issues that joint venture partners might resolve before they ink  a deal.

Yet the more issues on which the putative joint venture partners agree before the joint venture is formed, the less room there is for arguments and disputes and wrenches being thrown in the works after the joint venture is formed.

So next time you are ready to kill someone (i.e., your China lawyer) during the third month of your trying to work out a joint venture deal, just remember that every day of delay is probably increasing your chances of the joint venture generating you money, as opposed to falling apart.

What do you think?

By: Steve Dickinson

This post is Part Two in our two part series on how Chinese companies typically view investments and how this view impacts Western companies that invest in Chinese companies, and even how this can impact all companies doing business in China.

As I explained in Part One of this series, Chinese companies simply do not value investment to the same extent as Western companies.  Chinese companies value work. I ascribe this, at least in part, to Communism, which values the worker over the investor.

China’s pervasive attitude towards investment explains many of the difficulties foreign investors have in joint ventures in China. The typical failed joint venture works as follows. A failing Chinese state owned company is desperate for working capital. However, the enterprise has been cut off from life support from the state and no bank loan is possible. Or a private enterprise finds itself on hard times and no bank loan is available.

The venture then sets out hat in hand and finds a foreign joint venture partner. The foreign partner contributes cash, technology and markets. The Chinese side contributes land, buildings, staff and management. The foreign side takes the position that the Chinese side ought to know what it is doing and so it becomes only  minimally involved with the Chinese domestic operations. Through the hard work and dedication of the Chinese staff and management, the joint venture business succeeds. Often this success is won only after years of struggle and financial losses.

With financial success finally achieved, the foreign joint venture partner now thinks: finally, we can relax and earn a return on our investment. However, the Chinese side thinks exactly the opposite: finally, we can be rid of our foreign partner. The response to the success of the company is exactly the opposite. Why is that? The foreign side is of the view that without its investment, the company would have failed. The Chinese side is of the view that it has already paid the foreign joint venture back for its investment with a small profit. The foreign investor is doing no work and has done no work. Work is all that counts. The foreign joint venture investor is acting in bad faith by insisting on being paid when it has done little or no work. The Chinese side with then go to extraordinary lengths to get rid of its foreign partner, even if it damages the company in the short term. In doing this, the Chinese side thinks it is doing the right thing and the foreign partner that insists on staying around is the one acting in bad faith.

This attitude has been pervasive in China since I started working here in the 1980s. I have seen little or no change and I therefore expect little change in the immediate future. My discussions with Chinese businesspeople and Chinese lawyers only confirm this. The reason is obvious. China was and still is very much a communist country. Labor counts. Investment does not. This fundamental value assessment must be taken into account in designing your investment program in China.

The Foreign Entrepreneurs in China blog is in the midst of a very worthwhile three part series, entitled, “A China Joint Venture Survival Guide. 22 Facts and 22 Practical Tips.” The series is now at tips 9 through 15 and I like all of them. Not only are they good tips for those contemplating doing a China Joint Venture, most are are good tips for those contemplating or doing business in or with China as well.

Here is a summary of each tip, followed by my own analysis of it in italic font.

9. Your Potential Partner is Well Connected … Maybe Good, Maybe Bad. “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.”  Absolutely true. Whatever “power” your China joint venture partner has to help the joint venture, it likely has equal power to shut you out and keep you out should the tide turn. And trust me when i say that I have seen that happen far too many times.

10. Financial Reports: “I can’t live with or without you.” “Be aware that reports can easily be falsified, and a lot of relevant information may be missing.” Absolutely true. Check out “Buying A Chinese Company? Why China Deals DON’T Get Done,” for more on this.

11. Tax Planning: “Tax Breaks. Do not believe all you hear.” “Tax breaks are a common tool to lure you into a location that needs to be developed….We were promised tax exemptions on all those tools and parts required for our product manufacturing. It did not happen. Not even once….Your investment should make sense regardless of the tax exemptions or other promised benefits.”  Again, absolutely true. Unlike even five years ago, legitimate tax breaks in China are actually few and far between. You will be promised tax breaks that do not exist. You will be promised tax breaks that are not legal. You will be promised long term tax breaks that disappear. If the deal does not make economic sense without the tax breaks, do not do the deal. It really is that simple. 

12. Let me guess: your Chinese partner wants to contribute the land to the joint venture. 
“The Chinese partner always wants to contribute his own properties to the joint venture.” But it will usually be worth a lot less than claimed. it not only may end up being worth a lot less than claimed, it may not even be owned by your potential JV partner. Verify, verify, verify. 

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. So true. For more on this, check out “Cracking Down On Illegal Land Use In China. Do You Really Still Feel Lucky, Foreign Punk?” and “Eight Big Mistakes To Avoid In China.

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. You will need to monitor this closely and have good contracts in place. Indeed. 

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.  Just assume you are going to have to start over on this front.

I urge all of you to read the full post here.

Many moons ago, a company contacted us wanting to sue its Chinese joint venture partner for having “clearly” violated their joint venture agreement. We looked at their case and advised them not to bother pursuing it.

It had nearly every hallmark of the China deal gone bad, due almost entirely to the fault of the American company. Here were just some of its shortcomings:

  • The contracts between the Chinese and the American company were drafted by one lawyer. A local lawyer in the small town in which the joint venture is located? Who do you think this lawyer favored.
  • The joint venture was supposed to fulfill all sorts of obligations to the American company. In fact, it was these obligations that made the joint venture so tempting to the American company. But, the contracts were written so that these obligations were attached to the Chinese company that was entering into the joint venture, not to the joint venture itself. The Chinese company that had these obligations was (unlike the joint venture) utterly incapable of fulfilling them and, since it had no real assets, it was also a terrible candidate to sue. 
  • There were three contracts in two languages each, Chinese and English. The relationship between the three contracts was murky at best.
  • The English language contracts were horribly written and in some places incomprehensible. In the end though, we decided that was irrelevant. The English language contracts seemed to say that they would have the same force as the Chinese language contracts. But the Chinese language contracts (no surprise) said that the Chinese language contracts would control. This would mean that they would. Of course the Chinese language contract had all sorts of things in it that were very bad for the American company and that were quite different

Needless to say, this was a disaster in every way. But the two items most deserving of scrutiny are how the American company “just assumed” that the Chinese lawyer would equally represent the two sides and that the Chinese translation either didn’t matter or fairly transcribed the English.

Bottom Line: The lessons to be learned from this badly botched joint venture apply to virtually any China contract or relationship.

My firm recently wrapped up a fascinating matter (it is nearly always bad news when your lawyer describes your matter as “fascinating”). Even though the matter is nearly over, I am going to gloss over certain facts and make up other ones so as not to leave any possible identifiers. The thrust is entirely true and the result is as well, and my reason for writing it also remains intact.

Here goes.

Young Chinese Child falls from a window in a room in which an American employee of our client is one of the few adults. Child is very badly hurt. Very badly. It now appears his injuries will probably not be permanent, but he also may be in recovery for a year. His medical expenses by US standards were fairly low, but they are astronomical by Chinese standards, particularly for this less than large city. A day later, the parents of the child come with a lawyer to tell this employee that they want six figures (in US dollars, not RMB) from him and from his employer for the injuries that have befallen their child. They also go to the police and make the same request of this employee and his American employer.

The parents make clear to the employee that many in the town are behind them and that things will get much worse if payment is not received. The employer calls us and we immediately spring into action. We determine that the police do not seem to be buying into the parents’ story of guilt and they have not told this employee or any other employee of our client that they must remain in town or in China as either witnesses or suspects. We learn that our client is not terribly happy with its joint venture partner in this town and that it has no problem with taking its employees out of there and sending them home to sit this whole thing out. Though they feel terrible about the injured kid, they do not consider themselves responsible. Our research of the facts and the law and our meetings with a cadre of Chinese lawyers we trust all indicate our client is not liable. However, as everyone who has ever been involved in litigation anywhere in the world knows, not being liable and not being subject to expensive and time consuming litigation are two entirely different things.

We determine the best course of action is to get the employees out of this town as quickly as possible and on their way back to the United States. We figure that getting them out will change the leverage game entirely, and it does. The employees leave and the settlement claim by the parents immediately plunges. Now we can talk with all parties (the child, the joint venture partner who actually owns and maintains the building from which the child fell) from afar, pretty much stripped of any imminent threats. We agree to pay the parents something towards the medical bills and we (fairly publicly) ask that instead of the Chinese joint venture partner paying our client what it owes, that it instead pay all of that to the family of the injured child. Agreements are signed on all of this and we move on.

And yes, before anyone accuses me of this, I will come right out and admit it. The point of this article is that it pays to bring your China lawyers in early on a problem, rather than late. Early is better for the attorneys too, but only because many times when it is too late there is nothing the attorney can do (or charge for) beyond saying, “sorry.”