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For multinationals considering China as a destination in which to locate or expand their business, there are several checklists to bear in mind when signing up to a joint venture (JV). In some sectors, including financial institutions, certain service sectors and automotive manufacturing, JVs remain the only way for foreign parties to invest in China.

Form of joint venture

There is a major distinction between equity joint ventures and cooperative joint ventures. In the former, the amount of investment each shareholder makes should be consistent with the shareholding proportions, and also with the split of any dividend that is paid. Contractual joint ventures offer more flexibility in terms of the levels of investment from the shareholders, board composition, profit sharing ratios and the split of income from the disposal of assets upon termination. Over recent years we have seen more and more contractual joint venture arrangements, which allow foreign investors more leeway to adjust the split of economic benefits and mitigate the risk of the transaction.

Approval authorities

Perhaps the most important authority in the regulation of joint ventures is the Ministry of Commerce, which is responsible for approving the contract and articles of association of a JV.

Foreign investors need to be aware that the size of the transaction will determine which regulatory authority is required to give the final approval. They may also need to undertake a valuation process as well as a public bidding exercise. The Industrial and Commercial Bureau will provide the business licence, while the State Administration of Foreign Exchange will assess and approve offshore money flows and their subsequent conversion to RMB. When designing their structures, companies also need to bear in mind the size of the capital contributions that will be required, as well as the availability of local financing.

Mutual aid

Joint ventures offer a number of advantages over other forms of investment. Chinese companies may be attracted to the prospect of capital injections by foreign investors as well as the technology and expertise they can bring to the table.

Chinese companies, in turn, can offer the foreign investor a better understanding of the market and are able to help facilitate relationships with local government officials. If anything goes wrong, the joint venture partner in China is, in theory at least, able to intervene and ask for government support and assistance. How often this happens in practice, however, is unclear.

Choice of partner

Experience suggests that multinational companies may increasingly prefer joint venture partners from the entrepreneurial private sector, rather than from the state-owned sector of the economy. This can present its own problems. Entrepreneurs may tend to opt for a joint venture in order to benefit from future growth of the business, rather than sell out completely.

Whether private or state-owned, it is vitally important to find the right partner at the right location, of the right size and with the right spirit of the partnership. It is not easy to find good partners, and companies need to do thorough research in order to identify appropriate candidates. Many sectors and sub-sectors in China tend to be quite fragmented and it can therefore take time to find the right joint venture partner. On the execution level, the prospective partners to a JV need to assess the ownership split between them; most multinationals are seeking a controlling stake, or at least a clear path to control in a three to five-year timeframe. There are also corporate governance issues to consider, such as the board composition, what needs to be approved by the majority of shareholders, and what level of protections the parties are seeking. There also needs to be consensus on a dispute resolution framework, should any disagreements arise. Companies need such a framework in order to resolve the issue and agree who will buy out whom, at what price and timing.

Due diligence

Foreign investors need to do their due diligence on the companies they intend to partner with or acquire, as the joint venture structure will, for example, be unlikely to succeed if the Chinese company is in debt or does not have the expected capacity or technical know-how. All parties also need to work with their legal teams to establish the proportion of capital contributions and the contents of the articles of association of the new JV company.

Intellectual property

Another important consideration is that of intellectual property (IP) protection. Foreign investors should seek to design a structure that will protect their IP. However, IP cannot be effectively protected through a legal contract or a structure. The key factor can be more personal, such as choosing the right individuals to be the recipients of any knowledge transferred.

The valuation of IP can also be a source of disagreement. In many cases, we see a recognition of the value that IP brings. However, Chinese parties often wish to minimize the value of the IP contribution, as they remain sceptical of the economic value of IP presented in the business plan.

Identifying your target

We detect some evolution in the attitudes among entrepreneurs, as the younger generation appears more amenable to the idea of relinquishing control of part of their business, or entering into a joint venture, in order to access the capital and know-how of a foreign partner. However, one of the challenges remains the absence of a readily available or well-established source of information on potential acquisition or joint venture targets. Identifying suitable targets remains difficult and time-consuming. It is also a challenge to identify and approach the right people at any target that is identified. There need to be good strategy and tactics in place to do so.

Michael Jiang is a partner and head of corporate finance at KPMG in Beijing