As a growing economy fills company coffers with extra cash, many executives are thinking globally to stoke growth or cut costs.
Sometimes that means building a plant, but it increasingly means taking the once unusual step of an international acquisition.
China tends to get most of the attention despite its undeveloped legal system, local lawyers say.
This can create a few more legal headaches and require more homework than buying in the U.S. But companies are taking the plunge.
China has huge potential pay-offs.
The country’s economy has grown at around 9% or more the past few years, while the U.S. did 3.5% last year. France had 1.5% growth and Germany limped along at less than 1%.
China also is a massive market with 1.3 billion people, many of whom are beginning to move into a burgeoning middle class.
And China itself is looking for foreign investors to help privatize and expand its economy.
“Our clients are doing more and more in China,” said David Krinsky, a partner at the Newport Beach office of O’Melveny & Myers LLP. “They’re interested in opening significant operations in China and they’re often interested in making acquisitions.”
Buy China
Once a business decides it wants to acquire a company in China, there’s a good chance it won’t be a quick, easy process.
For starters, the company has to be in a market sector without restrictions for acquirers.
“If a company wants to acquire a company in New York, it’s very simple: ‘Do you want to, say, buy the stock or buy the assets?,'” said Peggy Fu, a lawyer for Paul, Hastings, Janofsky & Walker LLP in Costa Mesa. “The first question we ask in China is: ‘What industry is the company in?'”
Sectors with barriers include telecommunications, media and publishing, Fu said. The Communist government heavily regulates these industries to control the flow of news and information to its people.
Also, because of its key role in the economy, banking gets special scrutiny.
In most cases involving these sectors, China will only allow a U.S. company to acquire a minority stake in the Chinese company,and that’s if there’s an approval.
Other sectors are more open, including technology and auto manufacturing.
And many industries are opening up to more acquisition activity. Just last year the country allowed foreign companies to buy up to 100% of some of their acquisition targets instead of just a stake, Fu said.
Major Question
Once the sector is sorted out, another major question is who or what owns the acquisition target.
If the company is state-owned, expect more hassles. Any deal could need approval from the central government, along with provincial and municipal authorities.
This can lead to delays that can last a year or more, and final approval isn’t assured, Fu said.
On the other hand, acquiring a privately held or publicly traded company can take months.
If an OC auto manufacturing company wanted to buy a small, private manufacturing company in China, it might take around three months, she said.
As for due diligence, a major issue is accounting and how dependable the books are.
The whole idea of how accounting is done in the U.S., Europe or Japan is new in China. Even today, many companies still use a cash-based accounting system that only looks at cash going in or out in a month, Fu said. Receivables or invoices aren’t used.
This forces lawyers to find good accounting firms to not just check on a target companies’ books, but to practically create an accounting record from the ground up, she said.
“This really causes a lot of headaches for a U.S. buyer,” Fu said.
There are other issues to cover during due diligence, including whether the owner of the company has ownership ties to related parties that are customers. That can lead to padding sales numbers, said Howard Chao, a lawyer with O’Melveny & Myers in Menlo Park.
To avoid a lot of the due-diligence headaches, OC companies may want to look for targets that have strong U.S. ties, Chao said.
An ideal candidate would have backing from a U.S. venture capital firm and some U.S.-trained executives. That way, the books, the leadership, the general way of doing business will feel familiar and future legal issues can be largely avoided.
Still, one lawyer said acquisitions shouldn’t be bet-the-company moves.
“It’s kind of like bringing your divorce lawyer to your wedding,” said Bill Gay at Snell & Wilmer LLP in Costa Mesa. “If the whole thing collapses, do I have a way to out of this?”
Order in the Courts?
Whatever the case, U.S. buyers shouldn’t think the Chinese legal system will quickly take care of matters if the deal goes sour.
With a history that extends back only three or four decades, the modern Chinese legal system is in its infancy compared to its U.S. and European counterparts.
“It’s problematic,” Chao said. “The judicial system is not so reliable.”
And one big problem,although it isn’t true for everyone who rules from the bench,is many judges aren’t even lawyers, but merely old political appointees.
“It’s been difficult at times to have a rule of law,” O’Melveny & Myers’ Chao said.
However, times are improving. China now is a member of the World Trade Organ-
ization, and businesspeople, in general, are more aware of the international standards of law.
“People are becoming much more sophisticated about the law,” he said. “I think there is much greater predictability on legal matters.”
To be safe, lawyers tend to pick arbitration as the method of resolving conflicts with acquisition agreements. Although this is common in the U.S. as well, lawyers tend to push harder for it in China.
This gives companies the assurance they’ll be getting the disputes resolved under international standards. The arbitration often takes place in cities such as Singapore and Hong Kong.
“You generally see arbitration clauses in cross-border transactions,” said Paul Linn, a lawyer with Jones Day in Irvine.
