Due Diligence in China – Back to Basics

Due Diligence PicWe welcome old time collaborators and office neighbours the EU SME Centre, as one of our new blog contributors! Here’s their first blog post on due diligence in China:

European companies, both large and small, tend to be familiar with exercising due diligence, i.e. the checks performed to assess a potential business partner’s trust- and creditworthiness. With more than 24 million small and medium Enterprises (SMEs) active in the 28 Member States,  dealing with each other on a daily basis, and over one quarter of those SMEs active internationally (importing, exporting, or both), one might assume that European SMEs are well prepared to venture into the Chinese market., However, this is commonly not the case; doing business in China for the first time is likely to be different to any other experiences a European company has had for a number of reasons.

Booming business and lagging legislation

In many cases legislation, standardisation and enforcement have not been keeping pace with the staggering changes to markets during the last few decades. The Chinese authorities are working hard to build a regulatory framework that is consistent with realities on the ground. In the meantime, local and foreign companies alike are forced to struggle with inconsistencies, duplications and lack of information – so much so that not even local companies can be sure that the standard their product complied with a few weeks ago is still valid.

Everybody needs somebody

Despite that fact, local knowledge is crucial to successful market entry in China. After all, the Chinese language in itself is an obstacle hard to overcome for many Europeans. In addition, setting up a network of importers, distributors, suppliers, service providers and government officials takes cultural knowledge and social skills that differ markedly from European conventions. Most compellingly though, having a Chinese business partner is required by law for many of the essential business activities European SMEs will need to perform while doing business in China.

Trust, but verify

An unclear regulatory framework coupled with the need to find a trustworthy local partner makes due diligence a major concern for all foreign companies looking to penetrate the Chinese market. Checking a number of documents with the assistance of a Chinese lawyer in addition to conversations with the right people and a healthy amount of vigilance will give you a working knowledge of your potential partner’s financial, legal and operational background.  In the EU SME Centre’s publication “Knowing your partners in China”, seven rules of due diligence when considering whether to co-operate with a local partner are proposed.

The seven rules of due diligence

1.)    Assess how Chinese companies treat your partner company

Local knowledge is key to successful due diligence. Therefore, try to understand what other Chinese companies think about your potential partner and how they treat them. It is harder for Chinese companies to mislead other Chinese companies and there is less incentive to do so since local co-operation tends to be longer-term and the legal framework is clearer.

2.)    Do not take company introductions at face value

Personal networks and group solidarity are important in China. Therefore, be wary of contacts arranged by your potential partner. Any supplier, employee or customer engaged through the partner company may have an agenda benefitting the partner company rather than you.

3.)    Always ask yourself “Is this too good to be true?”

Opportunities might abound in China and prices might be low at times, but even in China wages and other costs are rising constantly. So be cautious whenever an offer seems unusually good and remain vigilant at all times.

4.)    Scrutinise the company operations

It is vital to make sure that your potential partner company actually exists and is able to do what they claim. Visit their premises, speak to employees, suppliers, and service providers involved.

5.)    Scrutinise your partner’s paperwork

There are a number of documents you can check to make sure everything is in order. Ask to see the business licence, the company stamp, any special permits and licences as well as land use and intellectual property rights certificates, and research the company at the state or provincial branches of the Administration of Industry and Commerce (AIC). Be on the lookout for mistakes in names, locations, dates, amounts given and stamps used. It is best to make use of the services of a Chinese lawyer for these checks.

6.)    Speak to others who have had dealing with your partner

The more independent sources you speak with the better. Check the consistency of the potential partner’s claims against the experiences of employees, competitors, suppliers, regulators, customers, industry media and even neighbours.

7.)    Do not delegate

Since business subordinates and outsiders might have reason to conspire with the potential partner company, take ownership of the due diligence process yourself. Do not rely on the conclusions of third parties but try to form your own opinion based on information received from as many different sources as possible.

In conclusion, two points should be stressed: Firstly, the vast majority of companies in China are honest and willing to develop sustainable business. Secondly, the seven rules outlined above are intended to serve as a rough guideline for preliminary due diligence only; to ensure the safety of your company’s assets a much more thorough investigation done by professionals is advisable.

Do you have any stories you want to share about your Chinese business partner(s)? Tell us about it!

 

EUSMEimageThe EU SME Centre is a support service provider for European small and medium-sized enterprises and business support organisations facilitating market access in China. Financed by the European Union, the Centre provides free of charge, practical information, advice and business tools to better equip SMEs to develop their business and tackle challenges faced in the Chinese market. For more information, including the report “Knowing your partners in China”, please visit the Centre’s website at www.eusmecentre.org.cn. For specific questions on due diligence as well as relating to business development, commercial law, standards and human resources, feel free to contact the in-house experts at the EU SME Centre at info@eusmecentre.org.cn.

 

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