When East Buys West: Regulation in Outbound Acquisitions
Handling the regulatory challenge in outbound acquisitions can be a different story altogether. Here are some of the issues that companies must watch out for.
Congratulations! After all the haggling, 14-hour flights, and 11th-hour dramas, you’ve closed the deal. Your firm now owns a business in another country. The bad news: that was the easy part.
Post-acquisition legal and regulatory troubles can present huge challenges, particularly if the acquisition is in a mature market such as the United States. “One of the greatest stumbling blocks for Chinese companies doing business in the US occurs after an acquisition,” says William J. Carney, a professor emeritus of corporate law at the Emory University School of Law in Atlanta and author of a standard textbook on mergers and acquisitions.
There are many, many requirements, and companies ignore them at their peril. “The US securities laws are detailed in their requirements for full and candid disclosures. This includes compliance with our accounting standards. A lot of Chinese companies have run into trouble because they aren’t well advised in these areas, or don’t take the advice seriously enough,” Carney says.
Depending on the market, there may be a lot to advise about. In the US, for instance, the Uniform Commercial Code runs to 2,698 pages, and each of the 50 states has adopted its own variation of those model statutes. There are also nearly 10,000 different sales tax jurisdictions, many of which have their own wrinkles as well. In New York, for instance, popcorn is taxed if it is sugarcoated or candy-coated, but not if it’s plain. In California, meanwhile, popcorn served in a movie theater is taxable if served warm but not if served at room temperature. And that’s only the beginning.
In addition, companies should also be concerned about intellectual property law—not just to make sure that they are not infringing on someone else’s patent or that someone else is not infringing on their IP, but because in some industries, patents have become both an offensive and defensive weapon: roughly 5,700 patent litigation actions were filed in 2014, according to a PwC study—a number that rose by 24% annually between 2009 and 2013, but took a breather (-13%) in 2014.
The median damage award between 2010 and 2014 was $2.9 million overall, $2 million for practicing entities (usually companies actually in the business of using or making the patented process or product), and $8.9 million for non-practicing entities (companies often derided as “patent trolls” that simply hold patents as a means to extract royalties from productive companies), according to PwC. It often pays to settle such claims: if they go to trial, the accuser wins about 2/3rds of the time.
Labor compliance can be a challenge as well. In the US, unions may be weak, but labor laws remain strong. Although brash unconcern probably isn’t a strong defense, it is reportedly a common one. Steve Dickinson, an attorney for Harris Moure, a Seattle, Washington firm that represents foreign companies operating in China, says Chinese companies have a pattern of violating US employment laws.
Carney has heard similar stories about Eastern contempt for Western labor law. “I recall one lawyer recounting a story about an Asian client with US operations that was sued for sex discrimination. When the responsible officer was asked why the female employee was passed over, he grabbed his crotch and said, “because she doesn’t have any of these,” Carney recounts.
In the US at least, simply ignoring or scoffing at legal risks is probably not a good idea. “Non-compliance can leave the buyer with disastrous unexpected liabilities,” says Carney. In the US, for instance, buying assets that include sites contaminated with toxic waste can lead to huge clean-up bills.
Particularly in mature, litigious markets, the relationship with the government is very different than back home in China, experts warn. In the US, it can be extremely difficult to reach some kind of understanding with an official.
Unfortunately, instead of trying to deal responsibly with a regulatory challenge, the first response of a Chinese company is often denial, according to an American attorney who has been working in China since 1981. “Basically, in terms of regulation, Chinese companies do not believe regulations are ‘real’. They do not believe they will be enforced,” says Dickinson.
One reason may be because they have come of age in a market where such skepticism is sometimes warranted: in a 2015 poll by Charney Research, 35% of 2,293 C-suite executives working in China said their business had to pay bribes or give gifts in order to operate. Transparency International ranked the country 100th out of 175 in its 2014 Corruption Perceptions Index, compared to 17th for the US or 14th for the UK.
Japanese companies faced similar issues when they globalized in the 1980s, Dickinson says, but after some of their deals went south, they analyzed what went wrong and learned from the experience. Chinese companies, however, don’t learn, he says. “It’s always somebody else’s fault, so they never do the analysis, so they never learn.”
Dickinson sees one root of Chinese company’s problem as a “general contempt for the intangible.” “Advice from lawyers, accountants, architects, engineers, environmental technicians is ignored. Intellectual property law and protection is ignored. All that matters is dirt and steel,” he says.
He finds the attitude so pervasive that his firm seldom represents Chinese clients. Once in a while, an optimist will take one on, he says, but the result “is always the same.”
Russell Brown, Managing Director of LehmanBrown, an accounting firm based in Beijing, says that Chinese companies are starting to use professional advisors these days, but acknowledges that it is still a fairly new concept for many of them.
Brown says that companies looking abroad should be careful to hire good advice about how to conduct their business. Don’t be penny-wise and pound-foolish, he warns, “or as said in China, ‘too busy counting the watermelon seeds so as not to see the watermelon.’”
Dickinson, however, is convinced that the disbelief in the intangible is so deep-seated that Chinese companies simply will not adapt. “It’s not that they’re just goofballs doing real estate in Minnesota, we’re talking every industry in the United States where Chinese get involved, they act exactly the same way. And they’re proud of it!” he says.
If Dickinson’s assessment is true, Chinese companies are making an expensive mistake: 84% of the value of the S&P 500 is now based on intangible assets—not plants and equipment, but intellectual property and a brand, according to a recent survey by Ocean Tomo, a US intellectual property consultancy.
Some of today’s most successful young companies have next to no real assets: Uber, for instance, is valued at $41 billion, but has only 550 employees, and owns no cars; Airbnb, the $24 billion vacation rental service, has 1,600 employees and listings for 1,500,000 places to stay, but owns no real estate.
But in Dickinson’s view, this disbelief in the intangible is likely to remain a lasting, if self-inflicted, barrier to entry. “The notion that many Europeans have and I guess a lot of Americans too that China is going to expand and do real business in Europe and North America… That’s never going to happen. I mean, they’ll still be the factory of the world and all that kind of thing, but to do business outside of China? Pure fiction, won’t happen,” predicts Dickinson.
Whether Dickinson overstates the case remains to be seen, but one thing is clear: those companies that do succeed abroad will need to prove him wrong.
To read all the articles in the When East Buys West series, please click here.
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