2. Key Rules for M&A in China
• Rule #1 – “In China everything is possible but nothing is easy”.
• Rule #2 – See Rule #1.
2
3. Important Factors for Deal Success
• Well-executed Integration Plan
• Correct valuation/Deal Price
• Effective Due Diligence
• Positive Economic Conditions
3
4. Factors Driving M&A Activity in China
• Continued growth in China
• Desire of foreign companies to enter the China market
• Desire for foreign companies to gain market share
• Consolidation of key industries – auto parts, cement and metals
• Activity in high technology, clean technology and sectors oriented
toward Chinese consumer spending
4
5. Roadmap for Completing a Deal
Acquisition of a chinese Company is a long, multi-step process often taking
18 months to complete
5
6. Critical Steps
1. Selection of Target
– Substantial research for potential targets must be conducted including
governmental policies in the target industry.
2. Relationship Building
– From the initial contact, foreign buyers should work to establish a friendly
relationship with the selected Chinese target. Foreign buyers are
encouraged to not only do business with Chinese partner from a pure
money-making perspective, but also work on “jiao pengyou” or making true
friends.
– Role of “mian zi” or “face” - Very important and the Chinese feel
embarrassed in taking advantage of a true friend. Foreigners are fair game.
– Trust - A good relationship helps a foreign buyer win the Chinese target’s
trust (to the extent possible), which makes business in China much easier.
6
7. Critical Steps
3. Preliminary Due Diligence
– Target’s value and market positions. Request and analyze information from
the Chinese target and comparing such information with the buyer’s own
independent research.
4. Letter of Intent
– In Chinese deals, the letter of intent should be more detailed than in US
deals.
5. Complete Financial and Operational Due Diligence
– A thorough due diligence includes, but not limited to the following (which is
not intended to be an exhaustive list): (i) Assessing Financial Statements
and Audits; (ii) Taxes and Filings; and (iii) Human Resources.
7
8. Critical Steps
6. Complete Legal Due Diligence
7. Acquisition Agreement and Related Documents
– The period starting from the execution of relevant acquisition agreements to
the closing of the deal is a sensitive stage for both parties. At this stage,
the foreign buyer is not the legal owner of the target and has no control
over the target’s business operation as the proposed deal is pending
approval of the applicable Chinese government authorities.
8. Government Approvals
– Unlike the United States, Chinese government agencies are active in every
transaction. Every acquisition must go through various examination and
approval procedures to consummate the deal.
8
9. Critical Steps
9. Co-Management of the Target’s Corporate Seals
– The procurement of the government approvals takes time. Buyer should
consider negotiating a “co-management” agreement whereby the target will
need the agreement of both parties to use the target’s corporate seals.
10. Closing
– After the documents are signed and government approvals obtained, the
parties may finally close the transaction.
11. Conversion of the Chinese Target to an FIE
– After the closing, the target will be converted to either a wholly foreign
owned enterprise or an equity joint venture.
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10. Letters of Intent for Chinese Deals
• Determine if the parties can agree on the structure and business points
of a transaction prior to spending substantial amounts of time, energy
and money conducting due diligence and preparing formal
documentation.
• Provide a summary of the proposed business arrangement;
• Fix a timetable for completing the transaction (which can be particularly
helpful in complex transactions);
• Identify the various contracts included in the transaction such as
employment or consulting agreements, license agreements or severance
arrangements; and
• Identify conditions to closing the transaction such as obtaining financing
and buyers due diligence review.
• Measure of commitment;
• Psychological effect on future negotiations.
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11. Key Issues in Letters of Intent for China-
Related Transactions
• Price
• Structure
• Target Closing
• Employees
• Confidentiality
• Exclusivity
11
12. Due Diligence
• Financial
• Tax
• Legal
• Human Resources
• Intellectual Property
• Environmental
• Other
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13. Due Diligence
“Where are the bodies buried”
Key Problem Areas
1. Ownership of the Target – practice of holding ownership in the names
of others
2. Financial records – 2 or 3 sets of books.
3. Permits/licenses – many companies operate outside of the scope of
their permits.
4. Ownership of Assets – often complex, no clear trail of ownership.
5. Tax payments – often negotiated, underpayment is the rule.
6. Bribery/illicit payments – are the rule not the exception.
13
14. Due Diligence Process
1. Background checks of the company, key owners and
management – Usually conducted by a third party
investigation firm.
2. Management Questionnaires –
3. Facility Visits –
4. Meetings/conversations with third parties – tax authorities and other
governmental officials, customers, suppliers, current or former
“partners”.
5. In-depth financial review –
6. IP Review – IP audit
7. Analysis of product development –
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15. The Acquisition Agreement
Key Limitations for On-Shore Deals
1. Structure of the Transaction –
2. Structure of the Purchase Price –
– Cash
– Equity – Must be freely traded on an overseas exchange and meet other
requirements; requires MOFCOM approval
– Earn-out –Difficult to use, rules require payment of purchase price within
three months, can be extended to one year; requires MOFCOM approval.
– Seller Financing/ Notes – difficult to use.
3. Indemnification and Holdbacks – Similar challenges to earnouts
4. Appraisal – Value of target’s equity or assets set by an appraisal firm
located in China.
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16. The Acquisition Agreement
Key Limitations for On-Shore Deals
5. Non-competition – Can be attached to employment agreement; limited
to two year term; after expiration of employment agreement, buyer
must pay compensation.
6. Governing Law – According to PRC law, cross-border acquisitions with
a target in China may only be governed by Chinese law.
7. Dispute Resolution – China is part of the New York Convention which
allows the enforcement of foreign arbitration awards in China. Hong
Kong International Arbitration Center, Singapore International
Arbitration Center are preferred forums.
16
17. Obstacles to Deals
The M&A landscape in China is full of obstacles including:
1. The laws and regulations are inconsistent and unclear.
2. Chinese companies lack transparency and due diligence is challenging.
3. The governmental examination and approval process is complicated
and time-consuming.
4. Strict foreign currency control.
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19. Key Challenges and Potential “Deal
Breakers”
In evaluating potential Chinese targets, there are many challenges.
1. Lack of integrity of the target’s management.
2. The inability to establish clear title to assets.
3. High expectations of value.
4. Unreliability of financial statements, lax regulatory compliance.
5. Ownership of the company itself.
6. Complex integration.
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20. Biography
James C. Chapman
Silicon Valley
T +1.650.843.7552
F +1.650.843.4001
E james.chapman@morganlewis.com
James C. Chapman is a Partner at Morgan, Lewis & Bockius, LLP. He focuses his practice on securities law, venture
capital, mergers and acquisitions, and international business transactions. He has more than 25 years of experience in
corporate and securities law and has been involved in over 300 mergers, acquisitions and financing transactions. These
transactions have included public offerings, private placements, debt financings, venture capital transactions, stock sales,
asset sales, mergers, reorganizations and recapitalizations. Jim also has a significant background in international
transactions, particularly dealing with China and Chinese-related companies. Jim was one of the early US attorneys
handling transactions in China. His experience includes both assisting Chinese companies investing and raising capital in
the U.S. and helping U.S. firms acquire Chinese companies, make strategic investments, enter into joint ventures,
technology transfers and distribution arrangements and otherwise operate in China.
Jim is also the author of over 50 articles including “Trade Secret Protection in China: A Perspective from China and Hong
Kong,” Association of Corporate Counsel (January 2013); “Mergers and Acquisitions - What Every CEO Should Know,”
ExecuSense (October 2012); “Joint Ventures in China: What Every CEO Should Know,” Law360 (June 20, 2012); Co-
author, “Clean Technology Innovation in China,” Eye on China - (February 2012); Co-author, “Clean Technology
Innovation in China,” Top Capital Magazine (October 2011); Co-author, “Mergers and Acquisitions in China Part II:
Anatomy of a Deal in the Middle Kingdom,” Corporate Finance Review (November-December 2011); Co-author, “Mergers
and Acquisitions in China Part I: Anatomy of Deal in the Middle Kingdom,” Corporate Finance Review (September-
October 2011); “Brave New World: Technology Transfer to China,” The Licensing Journal, Vol. 31, No. 7 (August 2011);
“JIAO PENGYOU - A Guide for Successful Business Relationships in China,” AMA’s Leader’s Edge (March 2011); Co-
author, “Mergers and Acquisitions in China: Current Trends and Challenges in the Middle Kingdom,” The Association for
Corporate Growth (January 2011); “Intellectual Property Protection in China - Building the Proper Foundation,” (May
2009); “M&A In China - Ten Strategies for Successful Cross-Border Transactions,” Asian Counsel (September 2008); and
“The Road to China: Ten Key Lessons for Doing Business in China,” The Licensing Journal, Vol. 28, No. 7 (August 2008).
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