Weblog with daily updates of the news on a frugal, fair and beautiful China, from the perspective of internet entrepreneur, new media advisor and president of the China Speakers Bureau Fons Tuinstra
About 90 percent of the China expats have left, estimates China lawyer Mark Schaub in his latest China Chitchat. And while new people are slowly coming back, those who left are struggling to sell their business, he says. What are the challenges they are facing, Schaub summarizes in the first part.
Mark Schaub:
Much more challenging is selling a business in which you have invested your lifeblood and passion for a long time. There is a combination of guilt (selling and leaving the employees behind) and fear (will those employees, the buyer, bank, authorities screw me over on the way out).
No entrepreneur I have met so far seems happy about the prospect – compounding this is that most are not so young (sorry guys – if I know you and you fall in this category and you are reading this then rest assured I did not mean you – I consider you to be very young) so this sale also impacts their future financial security.
The seller really needs to think in detail about what they want and weigh up differences but also think about how things will turn out for your specific business (i.e. special challenges or leverage or weaknesses you may have).
The common challenges with such sales are 1) certainty of obtaining purchase price overseas; 2) dealing with potential Chinese buyers and selecting the right one; 3) dealing with the transition (i.e. period in which you remain a minority shareholder and still be employed by the target); and 4) securing that the second sale (i.e. the minority shareholding) is secured in respect of timing, certainty and value.
Another challenge is to run the project quickly and smoothly. For almost all entrepreneurs selling a company in China is a new experience. It is common and sensible to be apprehensive and cautious, but a slow process is not in your interest as the seller.
Accordingly, to optimize the process you need to: 1) have a clear strategy, 2) understand what is possible, 3) have game played in your head all possible scenarios, 4) have a trusted group of advisors, 5) everyone is well briefed about your business and interests, and 6) carefully select the buyer (this is NOT just the highest price but also integrity and capability to implement).
China will implement a new PRC company law and veteran lawyer Mark Schaub expects most people will doze off before they make it to the end of that law. In his China Chit-Chat website, he summarizes the main changes and insists you should pay attention. He covers important issues like: “The new PRC Company Law sets a 5-year deadline to make promised capital contributions. Crucially this requirement will apply retrospectively. Ouch!” And who is the boss in a company, and how to fire a director.
Mark Schaub:
Being an external director of a WFOE was always quite a lark. You would go to board meetings (often in Hainan), were treated with great respect and as someone external to daily operations you did not really know why you were there, so you did not need to concentrate. Sometimes you would daydream about what superpowers it would be good to have.
Sadly, these halcyon days of daydreaming about being a superhero are consigned to the past as the PRC Company law ramps up (again) personal liability for directors. The threat of personal bankruptcy somewhat outweighs the pleasure of an occasional Gin and Tonic at a board meeting where all you need to do is nod and ask the occasional question to show you are awake even if such questions showed you to be not very well informed.
London-based China veteran Mark Schaub summarizes in his China Chit-chat newsletter the meetings his law firm had with 24 Ultra High Net Worth Individuals (HNWI) from China over the last three months of 2023. They were checking out opportunities in Europe and the Middle East, partly because their offspring was not really interested in joining their China business. They would look for lessons from their European counterparts but failed because of the differences between Chinese and Europeans, and because the concept of paying for professional legal advice did not yet take root among the Chinese visitors.
Mark Schaub:
All were consigned to or possibly happy to continue to live in China as their primary base. Europe and the Middle East are nice to visit but if you are in your 50s or 60s there is no place like home. Also most had the problem that they felt they had to continue to run the family business. Their children had studied around the world at elite institutions but seem unlikely that many would follow in their parent’s footsteps to run the whole shebang. One takeaway from the recent meeting was that Chinese private companies will need to recruit professional managers to run their family-owned businesses even more than is the case for European or USA counterparts – the kids seem to have little interest in running the family business. In some cases, one child was working in the business in China, but the others were living outside China.
Interestingly, almost everyone we met was highly motivated to do … something! But it seemed that they did not have a network in Europe or the Middle East or even know who to trust or how to go about things.
The greatest single motivation for almost everyone (at least stated) was their children’s future. All had educated their children in an Anglo-Saxon nation (either UK, Australia or USA). USA seemed to be less interesting due to both geo-political concerns but also the possibility of being shot.
It was interesting how multi-billionaires were desperate to get their offspring into an internship with an investment bank. One would think such people would have the network or connections to make this happen with a click of their fingers. You would think so, but you would be wrong.
Jiang was already president of China (and more importantly CCP party secretary) when I arrived in Shanghai (the city where he had just been mayor) in 1993.
The Western newspaper reports about Jiang Zemin when he passed seem to underplay both his achievements and his playfulness – playfulness being a word seldom associated with senior politicians in an authoritarian state.
The Western media has portrayed Jiang as an unwilling reformer (goaded by Deng Xiaoping to move more quickly and then with Zhu Rongji doing much of the heavy lifting) and authoritarian in cracking down on the religious group Falun Gong and that when he was Shanghai mayor he brutally suppressed protestors in 1989.
On the first point GDP per head in 1993 was USD 377 went up by almost 350% to USD 1290 by 2003. Accordingly, during Jiang’s tenure China went from being a very, very poor country to a poorer country poised to become a middle-income economy (i.e. USD 12,500 in 2022).
Jiang was extremely keen on attracting foreign investment. An early client of mine was the Rotterdam city representative office. They had opened several years before and we were just looking at some of their older records (not much to do in Shanghai in the early 1990s) we found a cache of their opening ceremony – and there he was Jiang Zemin with his beautiful, big glasses. It is unthinkable today but back in the late 1980s the Shanghai mayor was so keen on foreign investment that he would turn up to a rep office opening…
As to Jiang’s authoritarian streak this does not accord with my recollection – at least when discussing in Shanghai this back in the early 1990s the understanding was that Jiang Zemin was noticed by the upper ranks because he was able to keep the students calm without resorting to violence. As the students became restive Jiang went to Jiaotong University (his alma mater) and recited the entire Gettysburg Address to the students in English. I assume he then threatened the students that if they did not disperse, he would recite again. They dispersed.
I also remember that from 1993 to 2013 the taxi drivers were much more forthcoming in providing their opinions. This may also be due in no doubt to improved comprehension on my part but in the late 1990s one did not feel that the taxi drivers were feeling particularly constrained.
China sees mass development and urbanization at a breathtaking speed. Sometimes local governments want land back from foreign companies for this development. Veteran lawyer Mark Schaub looks at options and strategies when this happens at China chit-chat.
Mark Schaub:
Over the years I have worked on many projects where the authorities have sought to take back the land. This is not unsurprising as China’s rapid development and mass urbanization have led to residential blocks and commercial towers encroaching on industrial land. On a due diligence I was surprised that a cat food factory was built bang in the middle of a residential area. On quick reflection it was not that the cat food factory had moved – the residential area had surrounded. And so, as people often do behave “I am moving to live next to the cat factory because it is cheap and convenient”. Shortly after moving in it quickly becomes “Cat food factory smells – someone must make them leave”
Traditionally, relocations always totally stress out management – Can we get enough compensation? Will we become rich? Can we get a block of land nearby? Our business has an environmental impact – will anyone let us in? Will we be stuck next to that bloody cat food factory? Will the employees stay with the company after we move? How do we organize transport? How do we deal with business interruption?
The German government has become much more assertive about the country’s wheeling and dealing with China. Veteran China lawyer Mark Schaub visited over the past few weeks Berlin and Munich and felt the pulse of the German business communities toward China, he reports in his China Chit-chat. “Politicians in Germany have limited ability to influence or pressure German business. Consumers can be upset … but will become upset about something else 5 minutes later,” he writes.
Mark Schaub:
Geo-political Situation is Much Worse – a common theme was that media coverage was much more negative about China than in the past. Most also felt that the reporting was not particularly well informed nor nuanced. Hot topics include Xinjiang and Hong Kong. Many felt that China was judged much more harshly and subject to greater scrutiny than the United States. One friend who runs a China group told us that he was holding closed sessions on these sensitive topics because his organization places great importance on transparency and openness. This was somewhat dampened by his closing the door as he discussed this, but his heart is in the right place.
But Geo-Politics Likely to have Limited Real Effect – most felt that consumers and government may be more negatively inclined towards China but that this was unlikely to translate to much in the way of real action. Politicians in Germany have limited ability to influence or pressure German business. Consumers can be upset … but will become upset about something else 5 minutes later.
De-Risk not De-Couple – one German consultant reacted negatively to the term de-coupling finding it both exceedingly negative but also unrealistic. He has German medium sized businesses looking to de-risk the Chinese business but not quit China. It is more likely that the next factory will be in a site outside of China. However, probably not Vietnam as that is seen to be too integrated in China anyway. There was widely held agreement that really excluding China from the global supply chain was wishful thinking or unthinking populism.
COVID is a real Management Problem – most of the Mittelstand companies really felt that they are lacking insight into their local operations. In the past there was at least a bit of pantomime that the local management was following HQ rules and directions. Few feel the compulsion to even engage in such a charade now. One GM commented that what made her feel most comforted was that the local management in her entity were likely too stupid to be stealing. Normally this would be a red flag but I have met the management in question and I think she may be on to something there. In any event, COVID was really the biggest practical problem.
There is Still Interest in China – one consultant had conducted a detailed survey of 30 Mittelstand companies and found there was still strong interest. The major issue holding them back was concerns re IP rights. Although IP rights are a legitimate concern the level of understanding seemed very immature. Have you protected your IP legally? Do you have a strategy in place to protect the IP rights? If your IP rights are really so great and of great interest to the Chinese market you can bet someone will have bought it and reverse engineered the buggery out of it. Hiding will not work. Personally, I think the much greater challenges are: how do you launch a business in China if you cannot visit China? How do you compete with Chinese competition? Deal with an uneven playing field? These are all complexities that few mentioned.
The Chinese are Coming – it was striking how many Chinese companies were based around Munich – car companies, battery companies – it is curious why they all plumped for the most expensive part of Germany (for people, offices and factories). One German tech investor mused that he thinks to combat China’s new lead in new energy vehicles Europe of the 2030s will likely adopt the Chinese playbook from the 1990s for the auto industry – require Chinese companies to enter into JVs and forced tech transfers against market access.
Many foreigners and foreign companies are talking about exiting China, but as far as it comes to companies, very few do, says veteran China lawyer Mark Schaubat the China Chitchat. While doing business in China has never been easy, seldom firm fully pack their coffers, he says.
Mark Schaub:
In the last few years, we have had many foreign invested enterprises coming to us to discuss exiting China. However, only six liquidated at the end of the day. Most kept a toe or even a foot in the China market (some had lost an arm or a leg) or they sold their China business to someone else – sometimes paying to do so. For most international companies China is very much a hotel California experience – it starts with:
“This could be Heaven or this could be Hell”
And then after a while it becomes:
“You can check out any time you like, but you can never leave”.
To be fair over the years relatively few clients have wanted to fully exit China. Many decided to temper their ambitions or restructure how they did business (i.e. distribution model, OEM contracts etc.) rather than fully up sticks.
China veteran lawyer Mark Schaub looks back at the three decades he was involved with China and looks at how the country might look like in 2023, in his China chit-chat. What can larger foreign companies and the smaller ones expect? And of course: what is happening to the joint ventures?
Mark Schaub:
The Clock is Clicking for Joint Ventures – The PRC Foreign Investment Law came into effect on January 1, 2020 contains a time bomb for joint ventures (ok a bit overly dramatic but bear with me). One of its provisions abolishes the differences between Sino-foreign joint ventures and other types of PRC companies – primarily in respect of their governing structures (i.e. move to a shareholder meeting, board of directors and management). The law provides a five-year transition period for existing JVs so January 1, 2025 is D-Day.
Many may think that this is just simple paper shuffling – change the joint venture contract and articles of association. They may be right but normally life is much more complex. In addition to the mandatory changes the law also allows joint venture partners to agree to more flexibility on governance. All long term joint ventures have issues – opening up the joint venture contract will also open up a Pandora box of issues that have built up over decades.
Life has Moved On – 1993 was really so long ago. Back then Jiang Zemin was PRC president, Bill Clinton US president. The European Economic Community created the single market. Ukraine had recently become independent of the Soviet Union. Inflation in USA was under 3%. China’s annual GDP per head was USD377. People in Shanghai would ask foreigners if they like their own country or China better.
So, a lot has changed.
Things have probably changed in your JV or China business.
Has the market changed? Is the business still profitable? Has local competition become stronger? Does the current business model still meet market requirements? Has the business been impacted by practical changes? This is often in respect of procurement. Is the old way of doing business still the right way to do business? Are the contractual arrangements which are in place still fit for purpose? What are the real risks of 2023? Has the management changed? There must have been management changes. Worse still have there been no management changes?
How is your JV partner? Still looking healthy? Many successful SME JVs are based on a foreign and a Chinese entrepreneur forging a business together. Often outside of first tier cities. Wanting the best for their children a lot of these Chinese entrepreneurs sent them to Harvard or Oxford. These children also wanting the best for themselves are often unwilling to return to rural or industrial Sichuan or Liaoning province. Even if they return is this second generation tough enough and knowledgeable enough to run the business. They often have a less than perfect knowledge – in one case the founder’s son who showed us around the factory got lost and had to phone someone to find us. US and European family-owned businesses bring in family members or professional management early on – China often not so much. These kids may be more interested in trust funds than widgets.
The story that Western companies are fleeing China is as old as the presence of foreign companies in China. China lawyer Mark Schaub looks at the recent flare in Western media and explains why they are wrong, again, in his weekly China Chit-chat.
Mark Schaub:
There has been a lot of discussion about China’s role in global supply chains. Many (often by lawyers or consultants dealing in China who feel dejected) have been predicting that Western companies will be departing China and cutting China out of their global supply chains. Their reasoning includes 1) geo-politics makes investing in China or trading with China less palatable; 2) COVID has awoken Western governments to the dangers of over-reliance upon one supplier (especially if that one supplier is China); and 3) Western consumer backlash due to human rights concerns.
My answer is “Don’t think so”.
For at least 15 years there have been regular reports from some elements of the media in respect of an expected wave of “onshoring” and of moving supply chains closer to their home markets. Back in 2007 a journalist Sara Bongiorni wrote a whole book on trying to live for a year in the US without buying any products made in China. Hers was less a political quest and more just to see if this was possible. It does, however, serve to show that the “China is making everything” concern is not new.
Despite all of this I have seen little evidence in my own practice of Western companies ceasing to source from China. A notable exception is certain clothing that seems to have moved largely to Bangladesh. However, this seems not to have been due to human rights concerns or the strategic importance of Western consumers being able to buy a cheap T-shirt … or rather it is no doubt due in no small part to the strategic importance of Western consumers being able to buy quality products on the cheap. Most of us have an in-built prejudice that exports are unallayed goods whereas imports are a sign of weakness. Rarely do we consider how the importing public has benefitted from trade with China – in the world of 2022 are most consumers worried about East-West geo-political issues or inflation.
We always think this time will be different – COVID lockdowns and a single ship blocking the Suez canal all illustrated how incredibly complex global supply chains could come a cropper in a manner beyond anyone’s control. However, perhaps the better lesson is how quickly logistics can overcome temporary disruptions and how clever they are to work around problems. Even at the height of the Shanghai lockdown workers beavered away in closed loop environments to keep the port open and avoid massive supply chain disruption.
China lawyer Mark Schaub returned to London after three months of quarantine in Shanghai, including a COVID camp. He looks back at the experience in his resumed China Chit-Chat. How bad was it really? How different is it from the US? And: are his Chinese friends leaving Shanghai?
Mark Schaub:
How tough was Shanghai’s lockdown?
My impression is that Shanghai’s lockdown was tougher than similar European lockdowns – no going to the supermarket, no pharmacies, no exercise – but not as inhumane as often portrayed in Western media. Many poorer people suffered greatly but this is not unique to China’s lockdown.
One group that suffered in particular were the elderly – Shanghai’s lockdown was in many ways an e-lockdown. Many elderly Chinese people have modest lives and do not own a smart phone. A smart phone is needed to show your PCR test result and obtain the green code. Without a green code you cannot not go about your normal life (e.g. get on a bus, enter a shop or even come back home). Many older residents also rely upon their family – isolation hit them especially hard.
I think many forget how tough Western lockdowns were – in London there was no mixing outside your social bubble, difficulties accessing medical care, you could not visit critically ill loved ones, no funerals, … it was a lonely and isolating time. Shanghai’s had all that toughness and more … but its advantage was its relative brevity and geographic containment. If China was doing its lockdown when the West was doing theirs I assume it would not have been much of a media topic.
Foreign firms have been isolated more than ever from their China operations because of COVID-19 and the ongoing lockdowns. China lawyer Mark Schaub looks at the situation in 2022: “If you intend to continue with your subsidiaries in China then greater local decision-making power seems to be a likely pre-requisite to success,” he argues in his weekly newsletter. He looks at the good, the bad, and the ugly general managers.
Mark Schaub:
The Bad GMs often have the following traits:
Difficulty in seeking assistance – Often the manager feels it is a solitary responsibility to interpret China and deal with any difficulties which may arise. The problem is that such interpretation may not be objective (i.e. “fish cannot see the water”) or is more complicated and needs HQ support or is serious and HQ has a legitimate right to know what is happening.
Observe not Do – Observers are more comfortable in reporting difficulties to HQ rather than actually tackling the problems. Typically, these General Managers will blame anything other than themselves for a failure to get things done (e.g. the joint venture contract did not give them sufficient powers; the Chinese partner is being mean/difficult/unreasonable; the approvals have not been obtained, etc.).
The Hero – rather than complain about his situation, he revels in any difficult position he may find himself in. Very much like Hollywood movies the Hero cannot be a team player – having others to share the burden would distract too much from the star of the show. When the Hero does communicate with the head office, it is to (1) convince them that they do not understand; (2) cement a position as “our contact in China”. Heroes can normally only survive in General Manager positions if they have a patron in the head office. The reason being that they intend to infuriate everyone else by always replying “this is China”; “you do not understand”; “I have good guanxi” to any normal question one may pose. The good news is that once the patron falls, the hero will normally soon follow suit.
No matter how irritating bad General Managers are, there is a far worse category – the UGLY. The Ugly GMs come in many varieties but some of these include:
The “Partner” – this will typically impact a medium sized company’s WFOE/sourcing operations and flourishes when the General Manager is left to their own devices in China. This isolation has greatly increased since COVID. However, even in the past a visit by HQ personnel will be stage-managed like a Soviet state visit – no chance encounters with any other company personnel. HQ may feel uneasy as to their lack of knowledge of what is happening in their China outpost but are consoled that the venture is making a small profit unlike the JV horror stories. Responsible HQ personnel may resolve to do … something … to investigate its subsidiary in China as soon as there is more time available … but time never does become available … COVID … other fires to put out … other priorities … China is far away. While HQ procrastinates the General Manager will slowly evolve at some imperceptible stage from no longer seeing themselves as an employee but rather as a partner in the HQ’s China business. This is a problem.
The Thief – Unfortunately for some General Managers, the title “CEO” is more an acronym for “chief embezzlement officer” rather than “chief executive officer”. Experience is that since COVID there has been a spike in clients concerns in relation to procurement fraud, embezzlement, diverting funds, competing with the business etc. In my experience, such managers are a small minority but they can be local or expatriate. The most common characteristics are that they thrive in an environment that has little corporate culture, limited oversight, poor controls, no checks and balances and the GM has typically been in their position for a long time. Many people think that there is less such behaviour amongst expatriates. I do not think that is true – it is not that the expatriates are more virtuous they just have not been in their role long enough.
The Megalomaniac – my personal favorite Ugly GM is the Megalomaniac. He resembles the Hero but with two very important differences: 1) unlike the Hero, he does not have the company’s interests at heart – he sees everything as being solely for his benefit; and 2) he does not seek any praise from the head office as he believes they are all deluded fools. Megalomaniacs have either no successor (i.e. no deputy general managers) or an abundance of successors (i.e. five or more deputy general managers). The reason is clear. A potential successor would contradict the main tenant of the megalomaniac’s management philosophy – he is irreplaceable.
Foreign companies have been struggling how to manage their China investments for decades. Veteran China lawyer Mark Schaub, partner at KWM, looks at how the questions have remained, but the answers changed as China developed from a lucrative niche market into a major competitor for most industries, in his weekly Chit-Chat China.
Mark Schaub:
Thirty years ago, China was for most foreign companies a lucrative niche market with great potential but of limited sophistication. Today for many of these foreign companies China is a critical market that is increasingly complicated, regulated and above all, competitive. Thirty years ago, foreign business interaction with China was often simply sourcing or manufacturing for export or B2B (e.g. auto suppliers for VW, selling to China manufacturing etc.).
Back in those days there were many challenges – unclear regulations, IP protection, increasing labour costs, real estate issues etc. Today, I imagine for almost every business in China the number one challenge is COMPETITION – competition for market share, for talent, for opportunities.
While there will be risks, perhaps sourcing companies or B2B businesses can still be remotely managed to a large degree but this is far more difficult for consumer facing businesses or larger businesses.
Today’s China requires greater agility than in the 1990s – management needs to respond to competition, regulatory change and market trends – to be fair it has probably been sub-optimal for a decade to remotely micro-manage China operations from the USA or Europe. The impact of COVID could mean a business limping along sub-optimally may not survive.
In China, anything good will be snapped up quickly.
One client, a retailer of homeware, very successful internationally, attractive product range, homeware was a hot sector, product was competitively priced… what could go wrong? Well for one thing … real estate could go very wrong and they had a bricks and mortar model. Securing leases was crucial to the business but the European HQ was wary of perceived risks in doing business in China.
To combat this the European management came up with a very well thought out protocol to be followed when entering into a lease as illustrated below:
The HQ protocol was excellent at minimizing risk – in large part this was due to almost no leases being signed. Only the most desperate of landlords would have the patience to wait for the whole laborious and time-consuming process to unfold. Most leases were for basement space in non-performing malls. This killed the business in China.
China lawyer Mark Schaub, a senior partner at KWM, has dealt with many cases for foreign firms, accusing Chinese companies of infringements of their intellectual property (IP). In an interview with Gao Feng Advisory’s CEO Dr. Edward Tse, Mark Schaub shares some of his legal experiences in China at Wei Xin.
Mark Schaub:
The IP protection system is not perfect in China but it’s improving a lot. By way of illustration, we’ve got something like 5,000 lawyers in China and the busiest and most dynamically growing part of our practice is IP litigation. These IP litigation cases are mostly Chinese companies suing each other. This shows that IP rights are increasingly protected here and Chinese companies are also protecting their rights through litigation. They would not be doing this if it was not effective.
Ed: Many of our foreign clients are still very concerned about IP. The situation on the ground here in China has actually improved a great deal. Have you seen cases where foreign companies sue Chinese companies for IP infringement and won?
Mark: Yes. There have been many cases where foreign companies have won. When people think about IP, most people are thinking about things like DVD copies, fake fashion clothes or consumer goods. A lot of people address these kind of breaches through administrative processes – these do not result in very large fines. What we’re talking about today is more in relation to tech companies. For these companies it is important to deal with parties who might be stealing their technology. In those cases, foreign companies have won cases and the amounts of damages being awarded are rapidly increasing. In places where they have special IP courts like Shanghai or Shenzhen, it’s unlikely to be ’any strong bias against foreign companies. The main issue is often the foreign companies fail to take all the steps needed to protect their IP rights in China. Secondly, the problem has been that the amounts of damages awarded are relatively small. Chinese judges are not like American judges and are very conservative in awarding damages. But for IP holders, the situation is improving and the amounts of damages being awarded are getting larger now.
Ed: Many of my foreign clients are very concerned about whether that process is fair and transparent. What is your observation on the evolution of that process over the years?
Mark: I’ve found over the years that many people prefer arbitration but I actually have a preference for Chinese courts, because in the tech setting, Chinese courts are quicker. They’ve got more weapons in their armory. Enforcement is easier and the cost is lower. My experience has been that the most difficult company to go against is a private entrepreneurial company in a second or third-tier city. Those companies often have strong relationships with the courts and may be affected by local protectionism. The other extreme would be a large state-owned company or a listed company in Shanghai, Beijing or Shenzhen or one of the tier-one cities. Courts in these cities are more transparent and professional. Perhaps when considering IP litigation, it is important to consider what kind of party you’re going up against as this will likely determine the experience.
We’ve got one client whose software program was hacked and people were able to buy it on Taobao for 20 RMB. We have worked with Taobao and they are very quick when it comes to closing down infringers. Now, when we send Taobao a letter they immediately close down the concerned vendor. Accordingly, you have to be up-to-date and smart as to how to approach IP issues in China. It does not always make sense to spend lots of money on law firms fighting a major court case which may not lead to a real solution. You have to look at other ways to protect your IP. Look for strategic, clever and bespoke solutions rather than just following the normal process.
