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Panel Detail:

Tuesday, April 29, 2008
2:15 PM - 3:30 PM

Lowering Barriers to Investing in China's Small Businesses

Moderator:

Shelly Singhal, CEO and Chief Investment Officer, Crestwood Pacific Group

Panelists share a light moment as they analyze new investment opportunities in China.

Additionally, Lavelle described the changing nature of the Chinese economy and the transformation from "catch-up" development to the growth of highly innovative, R&D-intensive firms producing high-quality products and services that will be sold all over the world. What can we expect from China? "Don't be surprised when firms headquartered in China look to expand their operations globally, including making acquisition of U.S. firms and firms in other highly developed markets."

Panelist Charles Liu of Hao Capital discussed his experience doing business deals in China since 1975. First he noted that China's growth is phenomenal, but he warned Western investors that "you have to realize this is the first generation of entrepreneurs in China." Chinese businessmen and -women who grew small businesses into larger, more successful firms leveraged their personal, family and political capital to do so. Because of these ties and the dependence upon social capital, "if you try to buy out a firm like this, you may not be able to replicate the business success that the entrepreneur created."

Another challenge for Westerners interested in investing in, growing and scaling small Chinese enterprises is overcoming the social trust hurdle, said Liu. "It is very difficult for Chinese businesses to accept guidance or support from foreign investors," and in general, local venture capitalists do better in growing the Chinese SMEs.

In response to a question about the difficulty of contract enforcement, panelist Gary Locke of Davis Wright Tremaine LLP and a former governor of Washington State, said that that Western investors should be aware that Chinese corporate accounting practices are not necessarily aligned with international standards. Moreover, court systems are developing, but they're not yet mature — and in many instances are still corruptible. Additionally, the "last thing that Chinese leaders want is disruption of the people's "inner peace" — any kind of social disruption is bad. Therefore, Chinese leaders will avoid making policy changes that are likely to cause severe economic disruption leading to significant job loss, violence or protests.

According to David Tang of the Federal Reserve Bank of San Francisco and Kirkpatrick & Lockhart Preston Gates Ellis LLP, dispute resolution in China is to be avoided at all costs by Western investors, in particular because the government ownership of firms creates perverse incentives for party leaders.

Liu's multilevel friendships with the firms he partners with and invests with reduce his risk and uncertainty. Because firm governance is not particularly transparent and does not rely on the rule of law, investors must rely on social mechanisms to attain information parity about what is happening within the organization. This is the advantage of having a local partner.

Each panelist was asked how to advise Westerners interested in investing in Chinese SMEs. Lavelle said investors must do local due diligence, while Liu added that decision-makers must understand the whole investment picture from a strategic perspective. "Ditto, ditto," said Locke, "and I'd add that you have to be patient. Things are constantly changing in China." From Tang came this advice: "Adjust your timeframe for dealing with officials, business leaders, lenders and other market intermediaries."

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