China

Chinese Investment In U.S. Companies: Toss Out Your Assumptions

Chinese investors may not have the long-term health of your company at heart.

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China is now the world’s third largest overseas foreign investor, behind only the United States and Japan. Chinese overseas investments have traditionally been done by state-owned enterprises to source raw materials from Asia and Africa or to develop secure trading and manufacturing networks in those regions.

This meant that until recently, Chinese investment in the U.S. was rare. But investment in the U.S. by privately held Chinese SMEs is rapidly increasing. Though the motives for these U.S. investments vary widely, they are — surprisingly — not primarily focused on investment returns. They are instead usually designed to provide the Chinese investing entity with some other advantage.

Chinese companies in traditional export industries such as furniture, shoes, clothing and housewares are usually seeking to use their U.S. investment to create a secure market for their products. Chinese technology companies are seeking access to U.S. technology they can exploit in China.

These privately held Chinese SMEs typically seek only a minority ownership interest in the U.S. company in which they are investing. The SME wants to leverage its minority investment with an additional “side” agreement that will secure the benefit on which it is actually focused. The traditional Chinese exporter seeks to have the U.S. company sign a long-term product supply contract with the Chinese exporter’s own factory. The Chinese technology investor will typically seek a favorable long-term license for a key technology held by the U.S. company.

When making a minority investment, minority investors usually focus on minority investor protections, such as super majority decision rules or anti-dilution requirements. Chinese investors typically ignore these sorts of protections and are willing to fund the venture with minimal documentation. This leads the U.S. side to view the Chinese investment as “easy money,” which too often leads them to make fundamentally bad decisions.

In traditional manufacturing ventures, the common mistake is for the U.S. company to agree to an unattractive long-term supply contract with the Chinese company’s factory. In technology ventures, the common mistake is for the American company to agree to all but give away its key technology to the Chinese investor. When the lawyers alert our clients to the risks of these “side deals,” their usual response is something like the following: “Since the Chinese company is going to be a co-owner, we have no reason to be concerned about getting trapped into a bad manufacturing agreement or technology license.”

On the contrary, the Chinese investor rarely is concerned with maximizing its profits or with the long-term success of the U.S. company in which it is investing. Its only concern is with securing short-term benefit(s) for its own Chinese company. American companies taking on Chinese foreign investment need to understand how these “side deals” can harm them and act accordingly.

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Dan Harris is a founding member of Harris Moure, an international law firm with lawyers in Seattle, Chicago, Beijing, and Qingdao. He is also a co-editor of the China Law Blog. You can reach him by email at firm@harrismoure.com.

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