9 Issues to Look for in a China Acquisition

The current downturn is presenting a wide range of opportunities for cash-rich companies to acquire existing businesses at reasonable prices. Before getting out your checkbook, however, there are some important issues that need to be addressed. By following these simple precautions, investors can save themselves hardship and legal fees in the years to come.

While China's legal system has improved remarkably since liberalisation began, foreign investors still need to be aware of many special characteristics of Chinese company organisation and commercial practices. And even established Chinese companies should be careful about making acquisitions away from their home markets, particularly if they are venturing out of home bases in more developed cities to acquire businesses in third tier cities.

The following check list is intended to present investors with some simple guidelines for doing preliminary due diligence.

Check the Company File

Every company registered and validly existing in China has a Company File. China does not have a central registrar; instead the Company File is kept with the Administration for Industry and Commerce (AIC) at the district or township, municipal, provincial or national level where the target company is registered. The company file can give you important information about the ownership and scope of the company, including its current shareholders, registered capital, legal address, legal representative and business scope. In some jurisdictions, you may also be to access the company's establishment files such as the Articles of Association, list of directors, annual inspection reports and any penalties.

Check the Company Scope

Unlike in many other jurisdictions, companies in China are incorporated with very specific business scopes. A company legally established to produce computer hardware may not be authorised to sell software. Be careful to check that the company's current business scope that it is operating in matches precisely the business scope specified on its license.

Land

Land is often the primary fixed asset of any company and in China, establishing land ownership can be particulary complicated. Be sure to check for documentation on land use rights, building ownership rights, and environmental compliance. For more details on land use rights, please see this article :Understanding Industrial Land Use Rights in China .

Do a Thorough Risk Analysis

Be realistic about how much risk you are willing to accept in your business venture, and make sure you use reliable sources for assessing the amount of risk in your China venture. While most of the businesses that fail in China tend to blame their Chinese partner, or the shortcomings of the Chinese legal system, the frightening fact is that all too many foreigner investors seem to check their common sense with the left baggage at the airport when evaluating their investments in China.

Vague data or opaque explanations of risk factors that would be clear red flags in London or New York are often overlooked by over-lathered investors who find cultural pretexts for overlooking clear warning signs regarding investment risk. Keep the same corporate risk analysis policy for China that your company uses for any other country.

Get Chinese Professionals Involved

Conducting due diligence in China properly in China means getting local Chinese professionals involved. This is not simply because of language, but also due to cultural and other sensitivities to abnormalities which may reveal larger problems. Make sure that whatever advisors you engage have strong local teams, whether they be from international firms with offices in China or local firms.

Liabilities

China does not yet have a strong central credit reporting system for companies so checking for loans, guarantees and mortgage contract can be particularly challenging. Any reports offered must be verified against independent sources for confirmation.

Watch Out for Special Arrangements

Beware of deals that involve departures from laws or standard industry practices. Companies from out of town have often entered into agreements with promises from local officials that central government rules will not be enforced in the provinces. Indeed, often they are not. Problems arise when these regulations are suddenly applied - sometimes retroactively - leaving the company with little recourse. You must be ready to obey all Chinese laws and regulations, even if they have successfully been avoided to date. Seriously question any agreement where you are told you can ignore or avoid the law.

Human Resources

Ensure that all employees have up to date labour contracts and are registered with the local labour bureau. The company should also have a clear and detailed employee handbook. Having this documentation in place prior to an acquisition will help with resolution of any human resource issues after the sale and limit the new owners liability.

Use Multiple Information Sources

Reliable sources of information can be hard to come by in China, and rather than try to find that one consistent, authoritative source (which may not exist) the easiest method is to insist on verification from two to three different sources. Of course, this may vary with the importance of the information, but the best way to ensure reliability is to see if the same answer is provided by multiple sources.