China Due Diligence And Its Effects On Business - By: Ray Latimer

‘An institutional view of China's venture capital industry: Conveying the differences involving China and the West’, Garry D Bruton and David Ahlstrom- Journal of Business Venturing 18(2), March 2003, 233. When a firm has passed on its primary testing, venture capitalists in the West move forward with due diligence, generally including confirmation of the nature and level of the firm's product, output potential, market requirement, and status of key associations with other companies (Fried and Hisrich, 1994). When venture capitalists first moved into China, due diligence for funded projects in China was limited in scope; in part, for the reason that support activities upon which Western venture capitalists rely to perform such activities were not present [Bruton et al., 1999] and [Mann, 1997].

While venture capitalists are escalating efforts to conduct Western-type due diligence, the supply and accuracy and reliability of information is still troublesome. Regulations in China do not require exactly the same level of public information be provided to the government or other regulatory bodies as occurs in the West. Many cognitive institutions motivate the tight control of data and knowledge in China [Boisot and Child, 1988] and [Boisot and Child, 1996] . Under the central planning system, bureaucrats and business people management information is crucial to comprehending the market and local regulatory environment carefully, allotting it thoroughly to be able to achieve favors and other valued items [Boisot and Child, 1988] and [Boisot and Child, 1996] . As one venture capitalist revealed: It's quite common to spend three to six months more on due diligence [in China], in comparison with similar offers in the West. Particularly you must know what sort of connections the entrepreneur has, both with the government and other agencies. These may characterize essential assets for the firm. Consequently venture capitalists must anticipate to make greater efforts in China than in the West to be able to get and aggregate a larger range of data in executing due diligence.

Major areas to consider in due diligence: legal research of the bureaucratic steps important to rent chosen land, building certificates, total operational costs of the rent, ecological regulations, license life span checking, pre-entry tax advisory, taxes of owners, stamp duty tax, tax incentives, special incentives, import/export duties exemptions (if any), tariff rebate system for your goods, policies for foreign investors in certain industry. Commonly, the procedure will proceed the following (we summarize a complete due diligence system, other less demanding trades will warrant lesser investigations/steps where appropriate): a. A Memorandum of Understanding or Letter of Intent setting out the main heads of agreement that'll be signed in between Chinese party and foreign party, often accompanied by a formal appendix with particular agreements pertaining to the due diligence activity such as an exclusivity agreement and confidentiality agreement; b. Party will serve the counter-party with a due diligence document request list, detailing various documents/certificates which are expected from company; c. Report on the returned documents, and analysis of issues.

Request of further documentation in accordance with the findings. d. Independent verification with the following sources: i) Carry out interviews with administration; ii) Review registrations with local Administration of Industry and Commerce, as well as other applicable government filings; iii) Site survey; iv) Environmental audit. This could be especially applicable for the sale which you are doing, with the factory?s potential ecological impacts; v) Verification with banks; and vi) Employment of investigative/valuation agencies, where necessary. B. Information evaluated: Like other jurisdictions, there are certain areas of the organization which must be reviewed. We set out the aspects of particular importance below: 1) Corporate organization: a. Corporate structure; and b. Corporate approvals by appropriate government companies. Note: Corporate structures are extremely dissimilar to that of other countries, consequently, it is crucial to recognize the basics of Chinese corporate law to be able to know the ramifications of findings. 2. 2) Land: a. Land use rights; b. Building ownership rights; and c. Geographical compliance. Note: Chinese land ?ownership? is very unique in that it provides for a system of long-term leases of the land itself, and full ownership rights to the land. Documents must be looked at thoroughly, especially, if the land and/or property is of considerable value in terms of the transaction. 3) Debts: Loans, guarantees and mortgage contracts.

Note: China does not yet have a solid central credit rating system for companies. Consequently, any reports provided must be confirmed against independent sources to be able to confirm a similar, as the first report may simply lack information regarding the business, producing a positive report when, the truth is, there are several outstanding liabilities. 4) IP rights: Be sure that IP registrations are properly conducted, company is free from violation of others' IP rights, licensing agreements are properly concluded, etc. 5) Material contracts: Specifically, if you are merging or acquiring the organization as a going matter, the organization must be very careful to make certain that they fully understand commitments and investigate any outstanding commitments and/or liabilities thereunder. 6) Tax filings and payment: Ensure that taxes have been properly filed and necessary expenses have been made. (This will have to be conducted in coordination with an accounting firm.) 7) Regulatory/legal compliance: 8) Special permits and other approvals: This category is often based on the business extent of the target or counter-party to the settlement. 9) Employee matters: A solid workforce is specially crucial in China, given the concentration of foreign investment in labor-intensive sectors and vast population for the service business. 10) Pending litigation/claims: This investigation, as litigation is often difficult to predict, is coupled with powerful warranty clauses assuring the counter-party that there are no outstanding or expected litigations or claims; and 11) Insurance plan.

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