Crouching tiger: Buying a business in China

A number of UK consultants are scoping out acquisition targets in China and on the face of it, why wouldn’t you? The Chinese construction market is booming, the lack of activity in the UK means the need to find work elsewhere is urgent, and an acquisition can gain you an instant presence in the country or in a new market.

Hence RTKL, the architectural subsidiary of £427m-turnover consultant Arcadis bought Beijing architect AHS in August and Building understands that one of the larger QS firms is in talks to take over up to three Chinese consultants. Jonathan Reardon, a partner in Pinsent Masons, who advises on mergers in China, says: “There is a lot of activity from construction consultants in China at the moment and many are looking to do acquisitions either to gain a strategic foothold there or to grow an existing business.”

But acquiring a company in China is significantly more complex than buying one in Chelmsford, or even Chicago. However, for those considering this route to breaking into China, we’ve put together a seven-step guide to get you started.

1 Ask whether you need to do an acquisition
The case for entering China is pretty clear. The country’s economy is set to grow by 8.4% this year and huge chunks of the government’s £400bn financial stimulus package, announced in November 2008, are being spent on construction. Some £1.5bn is going on infrastructure up to 2012 and £2.1bn is earmarked for more sustainable energy plants, including wind and nuclear power. In the private sector, construction is being driven by industry, particularly the pharmaceutical and petrochemical sectors.

But why would you need an acquisition to break in? The boss of one UK consultant has been in the Chinese market for more than 10 years a decade and has offices in Beijing and Shanghai. He says: “Do I really think we’re fully in China? No.” He believes that to be a part of China’s building boom it’s essential to have bases in China’s second and third-tier cities - “even the third-tier cities have more than one million inhabitants”. And acquisitions are the best way to achieve that.

He warns, though, that if you’re going into China cold, an acquisition may not be the best approach. “Anyone who thinks they can simply buy their way into China will find it extremely difficult. You really need to take time to get to know how things work there as it’s very different to anything else you’re used to. A key factor is that contracts are not easy to enforce, which means trusting your business partners is even more critical.”

2 Do due diligence as never before
Chris Lowsely, China business adviser at UK Trade & Investment (South-east), the arm of the government that helps firms work overseas, says: “Due diligence is even more important in China than elsewhere as you need to check for bigger risks with both your target company and the individuals running it.” This includes, for example, considering whether the directors of the company you’re buying have been to prison - something that is easier to conceal in China than in the UK.

Reardon adds that you must also do due diligence on the company’s property. “It’s quite common in China for land ownership to be unclear so it’s crucial to dig down into the detail and establish whether you are really acquiring the land.”

You’ll need a local firm to carry out the due diligence, of course, and a good place to start is UKTI, which has a list of legal and due diligence firms in each region of China.

3 Get to know your target
Gareth Kirkwood is managing director of Atkins’ Chinese operations. He says Atkins is not on the acquisition trail, but has advice for any firm that is. It must, he says, go beyond due diligence and “get to know its partner before they marry them”. This is more important in China because (repeating the point for emphasis) contracts, however well written, are notoriously difficult to enforce. So it is essential to spend a lot of time with the senior managers, developing mutual trust. Your company and theirs will become a joint company so you need to have complete confidence in each other.

If your target is a state-owned firm, known as a design institute, things will be difficult, says PH Lai, head of China for Davis Langdon Seah (the part of Davis Langdon not bought by Aecom). Any decision to sell will have a political element. “It won’t just be down to a senior partner; it will be a decision for the relevant government department.

“And be warned, the state is often not interested in selling firms and I don’t see any design institutes in bad shape [and therefore more likely to be sold]. They are all very busy.”

4 Ensure you can extract profits
Lowsely says: “It’s essential to establish what you can and cannot do in China and that will vary according to the type of business, and the province, you’re in. Above all, you need to check you can remit profits out of China.” For this you need to get the correct licence and these vary in different regions. Lowsely says international accounting firms such as Pricewaterhouse Coopers can advise on this.

5 Keep the key people in the business
Because of the difficulty of enforcing contracts in China, there is a higher risk that people will leave after the deal. Reardon says: “Restrictive covenants that try to say people have to remain with the company or cannot compete with it for a certain period of time after leaving are difficult to enforce here. People just ignore them.”

He advises structuring the deal so it contains incentives for the right people to stay. “You might want to leave some shares in the hands of key individuals for a certain amount of time to keep them bound in and incentivised and you can build into the deal an arrangement to buy them out later.”

One approach used to prevent former staff members competing with you for some time is to keep paying them a percentage of their salary after they have left.

6 Be prepared for a long slog
The head of that consultant mentioned earlier, which is in talks over three acquisitions, says that you should expect a deal to take at least nine months. You must also be prepared to pay a large amount up front - he declined to say how much, but says that in some deals 100% of the price is paid immediately.

He adds that you must be ready to use a wide variety of structures, too, as his firm is doing on its current deals. RTKL has been among those using an unusual approach to deals - its acquisition of AHS was structured as a pure asset acquisition, rather than a share acquisition.

7 Avoid corruption
The Bribery Act that comes into force in the UK in April next year says a UK company can be prosecuted for corrupt activities perpetrated by any member of staff in any part of the world, even if they are locals. Reardon says: “Bribery and corruption is now a key issue for UK companies operating abroad and both are more prevalent in China than in other jurisdictions.”

Again, due diligence helps to guard against this: “Check whether the firm you’re buying has proper controls against corruption and whether they have any history in this area,” says Reardon. “Also, structure the deal so that you do not take on any risks associated with their actions before you owned them.”