VCs and other businesspeople who have worked in China for years offer the following tips to anyone planning to go there for the first time.
Find a Good Partner
Everyone we spoke with put this at the top of his list, but with three caveats: One, find a partner who has already done VC deals in your field in China. Two, do not form joint ventures with the Chinese government or with government owned businesses. And three, partner with an indigenous Chinese firm (as opposed to one based in Hong Kong or Singapore) if you can.
Get a Trans-Pacific Attorney
The legal and regulatory environment is changing so fast that if you don’t have strong legal counsel you are headed for trouble. And remember, every business or company you invest in must be an entirely legal entity. There can be no overlap of personnel or staff. The short list of firms mentioned include Baker McKenzie; Heller, Ehrman, White & McAuliffe; Jones Day, O’Melveny & Myers; Preston Gates; and Shearman and Sterling.
Without exception all of the investors interviewed by VCJ recounted horror stories about working with state-owned enterprises (SOEs), and how such efforts in transportation, financial and food companies all ended up in disaster. Warburg’s Chang Sun warns new investors that while the signs are out for the world’s largest garage sale and government assets are being sold at low prices, the value of such assets is frequently destroyed by managers involved in running former SOE companies.
Put Feet on the Street
Several VCs VCJ interviewed appear to be living on planes and out of suitcases. As they’re among the most successful firms, we won’t question their ability to make this work, but for long term success most venture capitalists told us that you have to be on the ground in China to network, make deals and know what is changing. Parking yourself in palatial Hong Kong offices doesn’t work.
Structure An Exit in Advance
Consider how you are going to exit your investment from day one. Unless you’re going to China for the long-term, this means investing via a Wholly Owned Foreign Entity. A WOFE is a wholly owned subsidiary of operating companies typically set up in the Cayman islands.
Choose the Right Location
China is as big as the United States. You don’t want to add to your travel time within the country. For example, if you’re doing anything with infrastructure, telecommunications, finance or transportation you need to be in Beijing, where you’ll spend your time lobbying for business permits.
In a society built on one’s ability to demonstrate patience in the face of adversity, the blustering behaviors of VCs don’t play well. To succeed in China you’ll need a long-term outlook, flexibility, humility and a non-confrontational operating style. In the aftermath of the Internet boom China’s leading Internet portals, all backed by VCs in our story, saw their stocks plummet. But after years of repositioning and hard work many of those companies are back on track: NetEase.com (Nasdaq: NTES) trades for about $38 a share, Sina (Nasdaq: Sina) is at about $29, and Sohu.com (Nasdaq: Sohu) is at about $18.
Get Ready To Rumble
Person after person warned of the tough competition that VCs face in China. Some of the challenges: the cost of capital is less for domestic Chinese firms and the model is skewed to local competitors by language and knowledge of the local market. If you’re going to survive in China you must pick businesses with a high barrier to entry, otherwise you’ll have competitors starting up the day after you hang out your shingle. Cisco found itself in competition with its manufacturing partner, Huawei. It took the partner to court to protect its intellectual property, but in the end, dropped its suit. Today, Huawei finds itself in stiff competition with Harbour Networks, a Chinese company started up by a former Huawei executive.