Joint venture structuring in restricted industries

[ By Chris Devonshire-Ellis, Senior Partner, Dezan Shira & Associates ]

Joint ventures have attracted some unsavory press in the past, with lurid tales of foreign investors being burnt and treated poorly by their Chinese counterparts. While there is truth to some of this, other problems with a China JV are often the responsibility of an errant foreign investor also. No-one likes to admit blame when things go wrong. In our firm, we are often called in to provide internal audits on JVs by the foreign investor or for mergers and acquisitions ? a surprisingly large number are doing very well indeed.

When investing in China?s restricted industries, you have to have a joint venture partner. Often the maximum percentage of equity allowed in foreign ownership can only be 50 percent. So what options are available to the foreign investor to mitigate the risk of not owning, on paper, a majority stake? All JVs are bespoke, so the situations and investment environment can vary considerably. But there are some well proven guidelines to follow that can assist you get the most out of your JV.

50-50 ownership

The problem with this is the potential risk of getting into a static management position later with both parties disagreeing on a future direction. At worst, a board at loggerheads and unable to agree on a decision can effectively wreck an entire business. I find it best to build into the JV structure a mechanism that can provide a way out under certain circumstances. It is better to have made a bad decision that can be reversed than to have a board unable to move in any direction.

There are a number of ways in which this can be accomplished. Agree to give up one percent and have the Chinese side own the majority, which in the case of respected partners should not be an issue if the management team is healthy and the business able to declare dividends. A one percent loss of dividends is a small price to pay for a united board. Alternatively, other mechanisms can be enacted within the JV articles to permit the chairman, for example, the deciding vote in the event of a split vote. This needn?t be immediately enacted ? it could be triggered if after say three or four board votes on the subject were spilt, allowing both parties time to negotiate or better understand the issue at hand.
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