An investor, as an alternative to acquiring the equity, may purchase directly part or all of the business and assets of a Chinese target company. Compared to equity acquisitions this represents a great advantage; in fact the foreign investor can selectively acquire only the useful assets of the target company (i.e. acquisition of a branch or “division” of the target company for example). When a foreign investor only acquires the assets of the target company, one of the main advantages is that the danger of the debt trap (i.e. situations whereby after purchasing the equity in a target company, the buyer realizes that the company is saddled with heavy debts, e.g. because machinery are mortgaged) is eliminated or reduced because the foreign investor is only purchasing selected parts of the target entity.
To guard against uncertain risk, foreign investors are advised to carefully check the
status
of the assets of the target company before proceeding with any asset acquisition. Generally, information on the
status
of immovable property and land can easily be obtained from the relevant government authorities. However the use of a
Due Diligence
is imperative when planning to acquire a Chinese entity.
(Lehman, Lee & Xu has extensive experience in providing due diligence reports and collecting intelligence about Chinese domestic companies and foreign invested enterprises. Visit the following web page:
http://spanish.lehmanlaw.com/resource-centre/faqs/mergers-acquisitions/due-diligence-practice.html
).
To find a company that is both attainable and can provide the proper synergies for the acquirer is not an easy task. There are many resources to help foreign investors do this, including consulting firms, investment bankers and even word of mouth.
In assessing a Chinese company, like everywhere in the world, obtaining a
Due Diligence
is a crucial step. Generally speaking the purpose of a due diligence is to allow the investor to find out more about the target company (of course in particular regarding its assets and liabilities) from various perspectives: financial, business operational practices, regulatory or environmental compliance. However, performing a
Due Diligence
on Chinese companies is much more challenging than carrying out
Due Diligence
on an European or American company. S Chinese companies are not monitored as diligently as foreign-invested enterprise in China (but is not always the case and thing are changing for Chinese entities also), this can lead to issues with the internal accounts. Chinese companies often give less emphasis to accurate bookkeeping. A lack of internal controls and poor records plague many Chinese companies. It is not unusual for Chinese companies to maintain several sets of books. For this reason when planning to acquire a Chinese company foreign buyers should engaged skilled, experienced investigative auditors. Conducting due diligence in China must often done by Chinese professionals, not only simply because of language, but also cultural and other sensitivities to slight abnormalities which may reveal larger problems.
When defining the price of the transaction, it is also necessary to keep in mind that preferred valuation methodologies in China can vary significantly from international norms such as net valuation and discounted cash flow. In addition, deals can often be set back by a lack of basic financial information. Therefore, foreign buyers should expect lengthy negotiations on price and terms with Chinese targets.
The legal aspects of due diligence typically cover matters such as: i) current licenses and approvals; ii) asset title certificates and related documentation; iii) loans and guarantees made to or by the (target) enterprise; iv) tax compliance; v) foreign exchange and foreign debt approvals and registrations; vi) labor disputes, trade union
status
, number of employees and the
status
of any redundancies; vii) contractual agreements and any non-commercial transactions; viii) litigation and arbitration, although the circumstances of a particular transaction might require additional matters to be examined.
It is noteworthy that certain State-owned assets must be valued before any transfer, (reference must be done to the following piece of legislation:
Interim Measures for the Supervision and Administration of State-Owned Assets of the Enterprises
, which is available at the following website:
http://www.fdi.gov.cn/pub/FDI_EN/Laws/GeneralLawsandRegulations/MinisterialRulings/P020060620324372344103.pdf
) and the resulting valuation report will be the reference point for determining the transaction price. Another reference, related to this aspect to look at is available at the following website:
http://www.lehmanlaw.com/newsletter/CentralEnterprisesJune282006.pdf
In the next entry I will introduce the “Key PRC Government Agencies” involved in the approval of the M&A transaction before to illustrate the taxation framework for enterprises restructuring in China.
– CRISTIANO RIZZI