CHINA ESQUIRE

Review time again as usual. Most interesting business article for the week comes from Seeking Alpha entitled “Progress or Pipe Dreams? Private Equity / Venture Capital in China.” ( h/t to China Law Blog) Well, its not really an article: it is a panel discussion from some people who know the industry better than most others. Here is what Dan Harris at China Law Blog said:

Project Alpha just posted the transcript from a very enlightening panel discussion on private equity/venture capital in China. The discussion was at JP Morgan’s recent China conference in Beijing. I attended this discussion and found it very informative.

Shaun Rein (Managing Director, China Market Research Group) did an excellent job moderating the discussion between Robert Theleen (CEO, ChinaVest); Joel Kellman (Managing Partner, Granite Global Ventures), and Brandon Lin (Partner, SAIF Partners).

If Dan thinks its a must-read, it probably is. Here are some excerpts I found interesting from the discussion:

Bob Theleen: At local, municipal and regional level, government is very much supportive of the PE industry. At national level things become more complex for the reasons you mention.

On the other hand the contradiction is there is not a mayor or a governor that I have ever met that does not say, my city needs capital; it needs growth capital and I want to support local entrepreneurs. Since the covenant of Beijing with regional government is you are more on your own, that regional government has to fend for itself. I think you will find that contradiction, that Beijing has to accommodate local government and it has to accommodate and support the PE industry, but how do you separate that out from issues like controlling the aggregate capital in a high-inflation market? That is a problem that China faces.

* * *

Shaun Rein: Is it hard right now for entrepreneurs to get capital?

Bob Theleen: I think it is very hard. It is harder because of credit tightening.

The good news is that our regional city banks are providing more and more debt. The aggregate savings of China, pools of RMB are accessible today through trust companies, through other financing sources. But that is an important component of making all of those kinds of business strategies effective.

Good stuff and worth a read. It reads pretty quickly.

The Los Angeles Times recently published an article entitled “Chinese Firms Bargain Hunting in U.S.” ( h/t to CDT).  Ironically, I had just posted an article recently about western companies going into China because the U.S. economy was faltering.  ( here)  And while I had also written about China’s growing economic muscle ( here), the LA Times article puts two and two together: Chinese companies are setting up shop in the U.S. because it is actually cheaper or almost cheaper to set up shop here.  Scary thought.  But the more the west goes to China and drives up costs (particularly raw materials and HR costs), the more that China might be tempted to bring more of that capital here.

Here are excerpts of the article:

Liu Keli couldn’t tell you much about South Carolina, not even where it is in the United States. It’s as obscure to him as his home region, Shanxi province, is to most Americans.

But Liu is investing $10 million in the Palmetto State, building a printing-plate factory that will open this fall and hire 120 workers. His main aim is to tap the large American market, but when his finance staff penciled out the costs, he was stunned to learn how they compared with those in China.

Liu spent about $500,000 for seven acres in Spartanburg — less than one-fourth what it would cost to buy the same amount of land in Dongguan, a city in southeast China where he runs three plants. U.S. electricity rates are about 75% lower, and in South Carolina, Liu doesn’t have to put up with frequent blackouts.

About the only major thing that’s more expensive in Spartanburg is labor. Liu is looking to offer $12 to $13 an hour there, versus about $2 an hour in Dongguan, not including room and board. But Liu expects to offset some of the higher labor costs with a payroll tax credit of $1,500 per employee from South Carolina.

Liu is part of a growing wave of Chinese entrepreneurs expanding into the U.S. From Spartanburg to Los Angeles they are building factories, buying companies and investing in business and real estate.

For years, investment between the U.S. and China flowed one way, with American firms spending billions in the Asian nation. But the Beijing government’s $5-billion stake in Morgan Stanley and $3-billion investment in the private equity firm Blackstone Group brought China’s overall investments in U.S. firms to $9.8 billion in 2007, up from $36 million the year before, according to Thomson Financial.

“It’s a lot of pressure going to the largest market in the world,” Liu said. But he thinks it’s certain to help his business become more competitive. “That’s one of the real benefits from this expansion.”

(emphasis added in bold)  We all know that the dollar has been weakening and that international players are finding bargains here.  It’s just an interesting surprise to discover its not just the CNOOC’s and the Blackstone’s that are coming to the west–it’s even smaller Chinese operations quietly coming in. It isn’t terribly surprising once I think about it a little–because it does make a lot of sense.  It’s just that I wouldn’t normally put two and two together in this sort of way.

What does this mean for corporate attorneys?  Or more specifically, for U.S. corporate attorneys?  The large M&A market is sputtering in the U.S. according to a recent article in the Recorder.  ( here, subscription required)  However, the mid-level deals are still alive and kicking according to the article.  These Chinese businessmen bringing business to the U.S. will be mid-level deals at best.  And more likely, need corporate attorneys who can help them set up shop: entity formation, real estate transactions, employment agreements.  In other words, basic corporate lawyers.  This is a bit of good news in a rather slow economy.

And for those M&A, LBO, and structured finance folks who are out of work with the spate of layoffs, maybe its a good time to do entity formation work.  Here’s a start for retraining:

whither the c-corp, s-corp, llc, lp, etc.?

Maybe I will get around to doing that analysis of different U.S. corporate entity types once my work slows down.

The American Chamber of Commerce recently published its “2008 White Paper on American Business in China”, which can be found here. ( h/t to Chinese Law Prof Blog) It is a very helpful overview of issues that American businesses will face coming into and doing business in China. The usual suspects are there: IPR enforcement (or lack thereof), human resources problems (the talent pool market), visa issues.

But there are a few encouraging trends in Part I of the report in terms of the way businesses perceive issues:

• Management level HR constraints is the top reported problem for 2008. (37%, up from 29% the year below). Again, I don’t think there is anything particularly new about this. This will be a problem for some time to come, especially in places like Beijing and Shanghai. I expect that this will be more and more of an issue as the 2nd and 3rd tier cities expand as well.
• Lack of transparency is fourth top problem for 2008, cited by 28% of respondents. It sounds pretty common-sensical. However, it ought be noted that this is down from 41% during 2007. That is a big difference in my mind. Especially from the Chinese government, where things aren’t always as transparent as western standards would prefer, this is a big thing. Very encouraging.
• Intellectual property rights infringements is not a newcomer to this list. However, it is the 6th top problem at 21%. And this is down from 26% the year before. I have been saying for the past few weeks that Chinese IP enforcement is getting better. This just validates this in my mind: even American businesses are taking notice, in spite of the rhetoric of the U.S. government at the WTO level.

Everything has gone down. Even bureacracy. (which places 5th) Except for the Human resources problem. I would note that there are some very good resources out there about this. I would start with Andrew Hupert’s China Solved Blog, which I follow and sometimes refer to on this blog. In fact, Andrew had an interesting post on point a few days ago. Other than, be warned that you will face stiff competition (to the point of the absurd at times) for good talent in major cities. Expect this.

So why the blog title? Because Am-Cham is so predictably American in their recommendations. I don’t disagree with any of them. However, it is urging the Chinese government to become more like our own government in how things are run. It won’t be easy. And sometimes, I think it well nigh impossible… at least, in this generation. These changes take time.

For example, the suggestions that Am-Cham came up with the following regarding how to fix deal with the HR problem:

Begin steps to reform the education system to encourage greater creative thinking, problem solving and teamwork. Courses should emphasize curricula that are more project-based and that encourage collaborative learning, which are vital skills in the workplace.

Reduce emphasis on one standardized college entrance examination and focus more on assessing individuals based on various abilities and skills that are applicable to the workplace. This includes team problem-solving, practical innovation and public service.

Re-evaluate the “985 Project” and “211 Project” aimed at strengthening the top universities and improving the curricula in order to propel the top universities to world class institutions in the next 10-20 years. Although we support the Chinese Government’s efforts to increase investment and standards in post-secondary education, these projects should include more cooperation and input from the business community to help ensure that students are learning the skills required to succeed in the labor market.

Relax hukou restrictions for qualified technical or managerial candidates and consider expanding the “Blue Stamp” system to other areas in China beyond Shanghai and Shenzhen.

Creative-thinking? Problem-solving? These are not fundamentally Chinese strengths. And in the current education system which emphasizes rote memorization and regurgitation, they will not be for a long time. So I don’t see these happening. Also, is this something China really wants? From a government level, I would want citizens who are hard working and listen to orders. That’s a cooperative citizenship. Second, where has America gone with its creative-thinking, teamwork oriented approaches? The math and science skills of children have plumetted. Sure, our youth are now great at teamwork–which is good practice for business and other services oriented industries. But even my high school teachers made fun of these “new” and “innovative” teaching methods. Why? Because they often produce poor students with no self-motivation and mental toughness.

I also don’t see the college entrance system changing anytime soon. It’s not just a China thing–it’s present in other Asian countries. It works. I don’t think Chinese college administrations will be ready for an American application system because of the sheer scope of the undertaking. There are going to be far more applicants in China due to its population. Really, this can kill resources in the universities like no other. I also question whether the American obsession with being an A+ student with high SAT scores and a varsity athlete and a humanitarian volunteer and being a participant of many clubs and <insert here> really helps anyone. There is a business for people in America who provide college admissions counseling. And I don’t mean in public high schools. The wealthy actually hire people to help their kids write their essays (”revise” the essay so they say), give guidance as to classes and extracurricular activities, etc. That isn’t really much better.

While I do agree that many of the suggestions would be helpful to American businesses, I want to caveat that they need to be taken with a grain of salt because the ideas are very American. Not that we expected any different.

Seems like everyone is talking nowadays about the poor growth and slow down of the Chinese economy. I started talking about the subject a few days ago, and now all I see is how China’s economy is slowing, the bubble is bursting, etc.

Here are some of the articles. First, from the Wall Street Journal ( h/t to CDT):

Some of the froth is finally starting to come off China’s booming economy.

Investment spending on factories and infrastructure, long the main driver of the nation’s growth, has begun to ease. Loans are harder to come by, with real-estate developers in particular feeling the effect of government curbs on credit imposed late last year. Some companies squeezed by higher raw-materials costs are reporting smaller profits, leaving them less money to finance expansion.

Such a cooling of frenzied investment and speculative bubbles is something China’s government has long sought, largely without success. Now, markets are showing the effects.

Of course, if you note the title, it is, “Finally Slower Growth for China?” So at least the Journal is considering growth for the Chinese economy at slower 10%. Well, is that really slow? Or is that an inflated number? I am going to guess the latter. But growth is growth. Growth does not equal recession.

And the International Herald Tribune (Reuters) posted an article entitled “Small investors in China get a lesson in stock bubbles” (also h/t CDT):

When experts periodically warned about the possibility of a bubble, prices dipped temporarily, then soared even higher, breaking records and inciting another mad dash to snap up equities.

“The market was going wild,” said Guan, 49, who a few years ago closed his real estate company to invest in stocks full time. “Everybody was talking about how much they had earned, how much more they would invest and which stocks had jumped 20 times, or even 30 times.”

That was last year. The Shanghai composite index has plunged 45 percent from its high, reached last October. The first quarter of this year, which ended Monday with a huge sell-off, was the worst ever for the market.

Suddenly, millions of small investors who were crowding into brokerage houses, spending the entire day there playing cards, trading stocks, eating noodles and cheering on the markets with other day traders and retirees, are feeling depressed and angry.

The two other Chinese markets also have dropped from highs last year, with the Shenzhen composite index down 38 percent and the Hang Seng index in Hong Kong falling 33 percent before recovering recently.

Other parts of Asia have been as bad, or worse. In India, stock prices have plunged 31 percent in Mumbai. They are off 31 percent in Japan and a whopping 53 percent in Vietnam, another booming economy. Angry investors have burned a securities regulator in effigy in Mumbai, and some are in tears in Ho Chi Minh City, Vietnam.

Few experts believe the stock plunge is a major threat to growth in the economy here. But there are worries that a prolonged downturn could reverberate through the Chinese financial markets - especially since a large number of corporations had aggressively shifted money, sometimes secretly, to play the market.

Note, even then that experts do not see the bubble bursting as a threat to the economy.

Even China Briefing got into the act:

China economy is expected to slow to 10 percent in 2008 according to a report released by the Asian Development Bank on Wednesday.

The slowdown in the economies of the United States and the EU are expected to have a pronounced impact on China as the country is more dependent on trade than the other developing economies in the region. However, while Asia will not be immune to the global slowdown, it will also not be hostage to it Ali said.

So now what? Is this a bandwagon idea or is the economy really about to tank? Somehow I doubt its the latter. I will not play Chicken Little and say the Chinese economy is about to keel over and die. Just because the stock market bubble burst and people can no longer play cards around the stock exchange, does this mean China is in dire circumstances? No way. Even with an inflated figure of 10% growth, China’s economy has far more resistance than what all of the doom-and-gloom media outlets have been saying.

For those in China, I think the key at this point is not to be stupid, and don’t bank your fortunes on the Chinese stock market. Which also means lawyers should probably be wary of taking equity in companies that list on China’s stock exchanges at this point.

And if you are sourcing in China, then it’s time to be really careful because some of the factory owners and suppliers that you work with may well be stock market losers. With inflation looming and a little less security in the economy (not to mention losses), guess where they can recoup some of that cost? With you and your order of course. (QC, QC, and more QC is prescribed) I wouldn’t be surprised if product quality fade is an indirect consequence of the bubble bursting.

Really, this is just some market correction. When the economy really tanks, you will know… and a few newspaper articles will only be the tip of the iceberg.

The weekend is here, and I guess that means its review time. It’s becoming customary here and I didn’t see a reason to buck the trend. I saw this article yesterday from Asia Times Online that notes that China’s banks are too cautious now with a bear market mentality. ( h/t to China Digital Times) Here are some excerpts:

When over 80 years of Wall Street history came to a crashing end with the demise of Bear Stearns on March 17, the shock waves of bankruptcy reached as far as Xinyuan Nanlu, Beijing. There, on the 9th floor of the Capital Mansion building, executives of CITIC Group immediately decided that there was no point in throwing good money after bad.

In October 2007, CITIC Securities, a brokerage controlled by CITIC Group, and US investment bank Bear Stearns had agreed a seemingly visionary mutual shareholding deal. Under the terms of the agreement, CITIC Securities would have taken a 6% stake in Bear Stearns for about US$1 billion, while the latter would in turn have taken a 2% stake in CITIC Securities, also valued at $1 billion.

Five months later, things looked a little different for Bear Stearns following misjudged subprime market adventures and facing a lack of liquidity. JP Morgan Chase, aided by the US Federal Reserve, was bound to fetch the whole of Bear Stearns for a mere $236 million in a speedily arranged fire sale that implied paper losses of about $985 million for CITIC Securities if its own deal with the Americans had gone ahead as scheduled. As sensible bankers, CITIC’s leaders went for the natural solution, balked at the investment and pulled out of the negotiations.

What could appear as an isolated tale of a merger and acquisition (M&A)deal gone bad might yet spell greater significance for the future evolutionary course of China’s financial markets.

In a natural extension of China’s changing approach to regulating its financial sector, the country’s largest financial institutions in the 21st century also started venturing abroad in their quest to tap into new growth areas. Consequently, with war chests bulging from their initial public offerings and/or China’s massive foreign exchange reserves, in 2007 alone Chinese financial institutions acquired equity stakes in Britain’s Barclays (China Development Bank), South Africa’s Standard Bank (Industrial and Commercial Bank of China), Belgian-Dutch financial group Fortis (Ping An) and US private equity group Blackstone (China Investment Corp).

CITIC Securities’ move for Bear Stearns also fell into this category of business line expansion coupled with increasing geographical reach. The deal’s dramatic cancellation as well as problems with other such ventures (the investments in Barclays and Blackstone have led to significant losses for the Chinese side) may induce renewed caution on behalf of Chinese policy-makers, regulators and bankers when it comes to loosening the rules governing the permissible business scope of the country’s financial institutions.

The fact that the pernicious effects of the subprime crisis will be around for a while only adds to this new cautious attitude. While caution is definitely in order in the brave new world of securitisation finance, a return to the world of rigid financial sector compartmentalization would not be in the best interest of China and the global financial system.

For one, unnecessarily strict regulation would make it harder and more expensive for Chinese firms and consumers to satisfy their increasingly sophisticated financial needs. At the same time, Western banks and securities firms are in greater need than ever of capital infusions from countries with savings to spare. Let’s hope it takes more than a wounded bear to scare off a dragon.

This is a total shame because we all know that China has a lot of money rolling around in its warchest.

Why is this important? Because I had thought that China and its attempts to inject its capital into foreign holdings and stakes in MNC’s would be taking off by now. Not that it isn’t happening, but seeing that China is becoming cautious is a bit unnerving for lawyers. It means less foreign investment, and therefore, less work to do for lawyers. I thought that the reverse M&A market and other types of corporate transactions would take off due to China’s new-found aggressiveness. (see here) Perhaps I was wrong. I hope I am not, and so for now, let’s hope that China continues to flex its financial muscles a little bit more.

Most of the China law blogs have been highlighting debates about what sort of entity (wholly foreign owned entity or joint venture, see e.g.) to form when your American or European clients decide to enter China–whether to market to the Chinese, find a new supplier in China, set up a factory in a 2nd tier city, etc. But CNN ran an interesting article yesterday that focuses on Chinese investment coming to set up shop in the U.S. and other places. In other words, the exact opposite.

The article reads ( h/t to CDT):

Amid the torrent of clothes, electronics and toys surging out of China comes a little-noticed export: international companies.

For centuries, individual Chinese have sought their fortunes abroad, creating Chinatowns around their restaurants and shops. Now, Chinese firms are going global, pushed by a government turned capitalist, pulled by untapped markets and armed with bundles of money from a thriving economy back home.

Auto plants are popping up in Latin America. A sprawling commodity bazaar promises a provincial Swedish city new life. A car parts distributor is snapping up ailing companies in the U.S. Rust Belt, a TV factory hums in South Africa and a high-tech firm is landing contracts to revamp the Persian Gulf’s telecommunication networks.

Chen and his fiancee, Joy Chen — both took American first names — moved from Shanghai to Atlanta to set up shop for General Protecht Group Inc., a company controlled by his father.

The Chinese corporate presence is still small overseas, but it’s growing fast:

• Chinese companies invested more than $30 billion in foreign firms from 1996 to 2005, nearly one-third in 2004-05 alone, according to an analysis by Usha Haley, a professor of international business at the University of New Haven. Computer maker Lenovo Group helped launch the frenzy in December 2004 by announcing it would acquire IBM Corp.’s personal computer unit for $1.75 billion.
• In the United States and Canada, Chinese firms now have about 3,500 investment projects, compared to 1,500 five years ago, according to an estimate by Maryville University professor Ping Deng. Large state-owned companies jumped ahead; medium and small private firms are catching up. Total investment in the U.S. is between $4 billion and $7 billion, Ping estimates. In Europe, Chinese acquisitions last year alone totaled $563.3 million, according to research company Dealogic.
• Last year, 29 Chinese firms debuted on U.S. stock exchanges, just two shy of the total for the previous three years combined, according to the Bank of New York Mellon Corp.
• The number of U.S. visas issued to Chinese executives and managers who transfer to U.S. posts within their companies nearly doubled to 2,043 between fiscal years 2004 and 2007. The current fiscal year is on pace to top that, U.S. State Department statistics show.

Chinese businesses are not just establishing offices and factories overseas. They also are developing and selling products under their own brands, rather than simply supplying Western firms in search of cheap manufacturing.

Unlike the Japanese, whose 1980s arrival in the U.S. was at first greeted as a threat, Chinese businesses are being courted by states including Michigan, California, Illinois and Georgia.

Few Chinese companies have been in the U.S. longer than the American subsidiary of the auto parts giant Wanxiang Group, which incorporated in 1993. The founder of the home company is one of China’s richest men. His son-in-law, Pin Ni, led the Chicago-area subsidiary from cheap parts supplier up the value chain by buying or working with companies that were distressed — owing to competition from China.

Wanxiang America Inc. has been welcomed for saving manufacturing jobs. Illinois has proclaimed a Wanxiang Day and Michigan offered the company subsidies.

“Even today you want to say, is there enough Chinese companies in the United States?” Pin asks. “I would say no.”

I am not sure if I now ready to sing the praises of Wanxiang America in the way that this article does, but this does provide an interesting thought. We have seen China flex its economic muscle in allowing some of its banks to go public and making heavy economic investment in Africa. It’s only a matter of time when we see more Chinese companies going head-to-head with American and European MNC’s. (maybe not competing head-to-head yet, but in the future it seems possible)

And of course, with such movement into America, guess who benefits? It’s not just the American workers who get jobs. It’s also the lawyers who will be helping such Chinese enterprises setup shop here. If you thought the choice between WFOE and JV was bad enough, you haven’t seen anything yet. In California alone, there are numerous corporate entities to choose from for such businesses:

• Corporation - S-corp, C-corp, or close corporation
• Limited Liability Company (LLC)
• Sole Proprietorship
• Partnership (general)
• Limited Partnership
• Limited Liability Partnership (LLP) - not applicable to the average Chinese business, but I have heard that some Chinese law firms are beginning to move into town.
• Professional Corporation (PC) - same comment

If this wasn’t bad enough, in other parts of the U.S. you have the business trust, the limited liability limited partnership (LLLP), the series LLC, etc. Sounds like Alphabet Soup to me.

And this doesn’t mention combinations of these various forms. Prime example: foreign investment engaging in a joint venture with an out-of-state entity could form a closely held California corporation for asset holding and then form an LP or LLC with the out-of-state entity. This allows pass-through taxation to the California corporation and the out-of-state entity, where you want taxation, and not at the joint venture level.

What’s a company to do? You can buy a publication like CEB’s Selecting and Forming Business Entities (disclosure: 2 partners at my firm wrote the chapter on Limited Partnerships and I “contributed” to this year’s major revision due to Re-RULPA, Corporate Code 15900-15912.07). And then pull your hair out trying to determine which iteration of Alphabet Soup is actually better. Or you can find a good lawyer. Or the more likely scenario for Chinese clients, both. (and then drive your lawyer crazy too… I can’t tell you how often this happens!)

In the future, I will try to cover some of the pros and cons as to particular entity structures versus others. But in the meantime, choose your poison. There sure are a lot of them to pick from.

Another news story that confirms to me the need for all people to be well versed in the use of WFOE’s and JV’s as investment vehicles for China. This one is is from the BBC and talks about how foreign investment grew 38.3% from a year earlier (which is a pretty astounding number if you ask me).

This piggy backs very well with my post, “ in the defense of the joint venture…” and the following comments, which picks up on the divide between WFOE and JV supporters. (key lesson from that: a lot of it depends on the circumstances, whether your client is an MNC or SME, the role of your Chinese partner, etc.–do not assume that one answer fits all)

Here is the brief article on foreign investment:

Foreign investment in China grew 38.3% in February from a year earlier thanks to a stronger yuan and large projects, the Commerce Ministry has said.

February’s $6.9bn (£3.4bn) figure was well behind January, when it more than doubled to $11.2bn. In January and February, investment grew by 75.2%.

The yuan has been allowed to appreciate 3% against the US dollar since January, which has attracted funds to China.

Also, firms have moved to China to cut costs and tap into growing demand.

Foreign companies are now looking at China as less of a base for low-cost manufacturing, and more as an opportunity to sell goods to a population with rising disposable incomes.

Commerce Minister Chen Deming put the jump in investment down to the yuan strengthening and an increase in large projects.

Analysts said that further gains in the currency would tempt greater foreign investment.

The most interesting line in there, aside from the fact that the growth is astounding, is that FDI is occurring because companies are looking to China as “an opportunity to sell goods to a population with rising disposable incomes.” Well, I know that no one has quite cracked the Chinese market, but someone has to figure it out eventually. It’s not so much a development as it is interesting to me–it only is a matter of time before a foreign company cracks the code on the Chinese market–especially the growing middle class. (see this article on the growth of the middle class, h/t to Bill Dodson) After all, retail sales seems to lag the FDI growth at a modest 20.2%. (forgive my sarcasm)

So quite an increase of investment in China. Now the question is, to catch that growth, WFOE or JV?

China Law Blog recently did a post about the revised edition of Guidance Catalogue for Overseas Investment Industries. However, what caught my eye was Bill Dodson’s response at This is China! because he saw the revisions as being a codification of what has already been happening with Chinese local governments restricting investment. (which is wonderful news because China has a long way to go to clean up its act environmentally)

I won’t comment as I think Bill’s post says it all:

At the local levels of government at which I work - second- through fourth-tier cities - officials have been talking for the past year-and-a-half about no longer accepting polluting and labor-intensive industries; eg, textile and chemical processing. The revision to the Catalog of Overseas Investment really just codifies what was already happening in wealthier Economic Development Zones (EDZs): a movement away from unpopular and energy-intensive industries. Fourth-tier and fifth-tier cities are more open to the light industries cited in the Catalog revision, especially the further inland one goes into China.

The shadowy Adjustment Catalog of 2005 that Steve refers to has been the proverbial writing on the wall for the EDZs that have been denying license renewals and business approvals these past two years for industries that no longer fit in the resource- and environmental-imprint China is trying to create over the next twenty years. There are dozens of those sorts of EDZs now throughout Jiangsu Province (especially after last year’s algal bloom in Lake Tai), and around the cities that are positioning themselves as IT-, BPO and R&D hubs.

As well, most of the kinds of companies affected in the catalog are the tens of thousands of Asian SMEs that we’ve all been reading about and seeing closing shop in Guangdong Province (Taiwanese and Hong Kong companies), and in Shandong Province (South Korean companies). Remember, they’re “foreign” too, and haven’t contributed much to the overall evolution of Chinese industry and society beyond sopping farmers from the fields and workers from shuttered State-Owned Enterprises. Now, many of those former employees are finding the work pays less than what they now have in their counties and towns - and even fields.

Do I think the announcement radically changes the shape of FDI flowing into China’s second- through fourth-tier (what I call “x-tier”) cities from Western countries? No. But the revision to the Catalog of Overseas Investment certainly gives EDZs more guidance in what kinds of investments to deny. However, it certainly behooves Western companies to check the sources ahead of time should they stumble upon a more devolved x-tier location that chooses to ignore the Catalogs and encourages a Western investment that actually contravenes national-level policy. Should policy winds change and suddenly the x-tier EDZ has to confess it’s sins, the Western company will find when it loses its investment that ignorance is no defense in China.

All good advice.

China Solved had a good blog post today about running a successful Chinese business, which includes an incremental exit strategy. There is a lot of good common sense in this post:

What can successful China entrepreneurs do to boost their household finances without destroying the company balance sheet?

Over the years you’ve tweaked the business model, found the right marketing & sales mix and were ready when demand caught up with your offering. What happens when your 5 year old business becomes an overnight success?

1) A sudden uptick in business activity may leave you with lots of money and lots of spare time. Probably not, though. It’s more likely that you’ll find yourself in a period of hyper-growth and hypo-cashflow. Don’t panic. Most small businesses grow at an uneven pace – particularly in China. Be prepared for a significant lag between higher sales and higher retained earnings.

2) Asset rich – household poor. Entrepreneurs are notorious for putting everything they have into their business – and that’s great. But as the business grows you will need a plan for transferring some wealth from the company accounts to your own portfolio.

3) Your business is not an ATM. Pay yourself a predictable salary. Big annual bonuses are fine – as long as you have some sense of how much you are earning. Someone bootstrapping a brand-new business probably doesn’t have a clear idea of how much he will earn in 2008 – but if you’ve been around for a few years and have a steady flow of business, you should be able to give a ballpark estimate of how much you’ll pay yourself.

4) IPOs and M&A grab the headlines, but successful entrepreneurs need a Plan B for cashing out. Leaving ALL your assets in the company can be risky. China business is famous for stories of successful entrepreneurs who ended up running into trouble with partners, bureaucrats, suppliers, key clients – and changes in regulations. Make sure you have a cushion in case the business suffers a major shock.

5) Incremental cash-out options. While living off your expense account is a bad idea, retiring on the company may be a winning strategy. Entrepreneurs and owners should consider setting up in-house pension plans, education funds and health insurance programs that preserve your business’ capital structure but still provide for the owners’ long-term financial health.

As I read this, it occurred to me: this applies not only to Chinese businesses, but domestic ones as well. I have heard from my colleagues and friends over and over again how they want to start a new business, do this and that, and talk about their product and target audience. No one, however, plans ahead to what to do if the business is successful aside from saying, “we want to get bought out by [insert big company name here]”. You cannot plan that way. Not everyone will get bought out by Microsoft, Google, and Time Warner.

These are all good suggestions for Chinese people running business in America, especially smaller sized operations. And it is still fine advice for American companies run by whomever. The key: plan ahead. Recalibrate your plan after 1 year, 2 years, and 5 years. But plan ahead and don’t expect the white knight to come for you.

I saw two articles that I thought can be partially aggregated because they both have to do with Chinese flexing its financial muscles. This is important as Chinese corporate attorneys should have reason to cheer of future international deals.

From Asia Sentinel (h/t to CDT):

The obscure China Development Bank is to be transformed from policy lender to international player

The China State Council’s plan to turn the China Development Bank into a commercial institution should transform what has been an obscure policy bank into a global financial player. It is also an indication of how China, besides routing investments through its sovereign investment fund, intends to use some of its massive US$1.4 trillion in foreign exchange reserves.

Approval should come soon for the 14-year-old bank to list on the stock market in the first half of this year, and it should quickly become both a major lender to the booming domestic market and an international investor following both its own commercial instincts and national policy objectives. And, while it may be obscure, it is already China’s most profitable bank and one of the biggest bond issuers in the country.

Even before the change, the bank has been aggressively carving out a foreign presence. As an indication of its ambitions, it acquired a stake in Barclays Bank last July, has invested in six overseas funds, including two worth a combined US$10 billion in Africa and Venezuela, and was about to bid for a stake in Citibank in January when the State Council vetoed the idea. It is looking eagerly for other foreign acquisitions.

Note the words “global financial player” and “overseas funds”. What does this mean for the lawyers? Corporate work of all sorts. I foresee M&A (perhaps reverse M&A would be more accurate), corporate securities, and financial work springing up for not only Chinese attorneys, but also foreign attorneys involved in China work.

This news was big enough already, but here is another article from China Digital Times entitled, “In the Midst of Market Woes, China May Invest Even More,” which states:

In China’s latest move to flex its financial muscle, The Wall Street Journal is reporting that China’s state-owned investment fund, China Investment Corp., may invest upwards of $4 billion in a new fund being started by J.C. Flowers & Co.

In an interview with The Wall Street Journal last week, Lou Jiwei, chairman of CIC and former vice minister of finance for China, said the state investment fund was looking to invest in “portfolios” of companies, rather than individual firms.

An investment in a fund managed by J.C. Flowers would fit that criteria. The U.S. firm, run by former Goldman Sachs banker J. Christopher Flowers, specializes in buying financial companies. His firm made headlines recently for backing out of buying student-loan provider SLM Corp., better known as Sallie Mae, for $25 billion.

Further in the article, speculation as to why J.C. Flowers stems from a report that CIC had invested $5 billion in Morgan Stanley in December of 2007.

By investing in a new fund being formed by Flowers, CIC would be able to indirectly invest in different companies and also inoculate itself from any political backlash that could arise from investing directly in iconic American companies.

It is also worth noting that the Wall Street Journal has found a new way of referring to China’s investment capital (emphasis added):

CIC was formally established in September to earn better returns on China’s huge pile of foreign exchange reserves, which now total more than $1.5 trillion.

As a point of reference, that “huge pile” was last reported at $1.4 trillion just 4 months ago.

I think this validates my thoughts regarding the bright future for China corporate work (financial, M&A/reverse M&A, securities… and perhaps PE, LBO, cap markets). I will not complain about such a predicament.