How I Learned to Stop Worrying and Love Joint Ventures

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This article originally appeared in Agenda magazine under the much more informative, yet less funny, title: “A Worthy Venture: What Sino-foreign Joint Ventures Have to Teach Us.” Check out the current issue here.

Conventional wisdom says that one should avoid a Sino-foreign Joint Venture (JV) if at all possible. You have to deal with a partner, they take a while to set up, there’s the partner situation, and management can be complicated. And oh yeah, you need a partner.

So why am I offering up a column that seemingly lauds the JV? Does conventional wisdom have it all wrong? Not at all. The advice is still excellent, and I certainly try to steer my clients clear of such entanglements when I can. That does not mean, however, that you should ignore the lessons of JVs, even when the China deal you are contemplating is completely different. My years in the classroom have shown that if my law students can thoroughly understand the way that JVs work, they can do just about anything.

For example, let’s say you own a valuable trademark and wish to license it to a Chinese manufacturer. Not even remotely similar to a JV you say? I beg to differ. That licensor-licensee relationship looks a lot like a JV partnership to me, although the commercial terms may be somewhat different. That License Agreement will share some of the elements of a Joint Venture Contract, and the operational end of the arrangement (i.e., how things work out “on the ground”) may end up looking very much like a JV, depending on how involved the licensor is in the China business.

Even an investor looking to drop some cash into an offshore-listed Chinese company could learn a thing or two from Sino-foreign JV history. Consider the recent problems we have seen with Alibaba, GigaMedia, and ChinaCast Education; the common theme here is local management fighting with foreign investors. Sound familiar?

If you are still with me at this point, you might be wondering just what JV lessons are most instructive. If I am going to spend my weekend researching Beijing Jeep and the failed Danone-Wahaha partnerships, would should I be looking for?

You may wish to start with the following:

1. Legal and Operational Control – JVs would not be challenging without the issue of control. Because you are stuck with a partner, there is a constant struggle in many JVs over who has the legal ability to make decisions and who has the de facto ability to do so – in many instances, these are two different parties. When you read up on your Sino-foreign JV history, consider what sort of legal and actual control issues pertain to your own deal.

2. Relationships – Most China consultants you talk to will totally inflate the importance of relationships (guanxi) to modern business culture. Guanxi is still a big deal in China, but for many commercial deals, it is much less important than it used to be. On the other hand, most deals involve one or more key parties whose cooperation is crucial to your success. A JV presents the most obvious example, but licensees, manufacturers, buyers and distributors are just as important. Take a look at messes like the Danone-Wahaha JV/litigationfest, and you can find many mistakes to avoid. Treat that licensee like you would a JV partner; the relationship will be much better for it.

3. Trust, but Verify – Ronald Reagan’s oft-quoted phrase about U.S.-Soviet relations, which he borrowed from a Russian proverb, is always good advice for JV partners. There is a good reason we lawyers draft those lengthy, hard to read contracts. But that is not nearly good enough. JV partners should by all means work on their relationship and keep it friendly, but at the same time, mechanisms must be built into place that allow the partners to check up on one another’s activities, just to keep everyone honest. This usually involves lots of disclosure, inspections, and hopefully sharing of operational control. Once again, what’s good for the JV is also important for that licensing, distribution or manufacturing deal. You really ought to keep track of what your licensee, distributor or local factory is up to, and not just when they are busy churning out widgets on your behalf.

4. Due Diligence – Most investors understand that if they are contemplating a multi-year equity deal involving a company from another country, some sort of investigation is warranted. That prospective partner might have financial trouble or a cloud on its land use rights. Perhaps it used to launder cash for Golden Triangle drug runners or manufacture shell casings for African dictators. You never know until you start digging. If you buy into this logic, though, why would you jump into bed with a licensee or distributor, for a multimillion dollar and multi-year deal, without also checking out that company? JV horror stories abound of what can happen when those skeletons are left in the closet, only to pop out later, and always at a most inconvenient time (e.g. M&A, IPO).

Just to be crystal clear: I still do not like Sino-foreign joint ventures as investment vehicles, at least most of the time. Too few benefits, way too many downsides. But as a teaching tool, an avenue to enlightenment for you prospective investors looking to crack into the market and in need of some quick historical lessons? JV case studies should be at the top of your reading list.

2 responses on “How I Learned to Stop Worrying and Love Joint Ventures

  1. Marius Van Andel

    Excellent analysis – I would add:

    Legal and operational control: Only JV’s among equals should be consided – and only among MNC’s, . . . . . . . . really

    Relationships: Guanxi Schmuanxi – it is for the birds – I personally don’t do business with friends if I can help it – anywhere! They expect too much and if it goes south, I feel responsible for their loss!

    Trust: If you cannot, no contract will help – just start with small deals before considering the big one

    Due dilligence: There is no such thing as enough in this context

  2. Hua Qiao

    I would also add,

    1. Get the metrics for evaluation set up early. Put in place a way to monitor that the metrics being reported are real. Structure exit paths in the agreement.

    2. Seek control (or at least veto rights) over personnel and have someone of a high level in the accounting/finance group. These points will be really hard to win if your partner is an SOE.

    3. Be prepared for a wild ride. The reason that people talk about relationships so much is that no matter how much you try to fashion an agreement that covers every contingency, there will be situations encountered that are not provided for in the agreement and you and your partner will have to have a good enough relationship to work through the issue in an honest and equitable manner. China is just too volatile and the government is too meddling to be able to foresee the pot holes ahead.