Part III: The Guanxi Joint Venture – A Case Study in Truth or Consequences
Two parties recently met to discuss a new business venture in China. On one was Bob – an American small business owner looking to expand into China, and the other was Cindy – a Chinese entrepreneur who wants to partner with him.
The first meeting was textbook cross-border business courtship – both sides were chatting about big-picture business plans, impressions about China business and their own personal views and experiences. It was typical of the relationship building session that many American and Chinese expect in the early stages of a partnership negotiation. Bob then did something very smart – and very significant. He said, “So it will be an equal 50-50 partnership between the 2 of us, right?” Cindy answered, “Well, I have family connections in XXXzhou who have guanxi with the local government, and they may want a percentage.” The conversation then resumed course.
2 points make this conversation a very important case study for Americans doing deals in China:
1) The American side broached a substantive business issue without breaking context. It was still light, big-picture and friendly, but the westerner made the decision to discuss REAL business. Furthermore, instead of just making an assumption based on what seemed obvious to him, Bob asked a naïve question about the basics – and then shut up.
Many novice American dealmakers erroneously believe that the early-stage discussions are all lightness and touchy-feely platitudes. Not so. But when Americans talk about business there is a tendency to get overly formalist and ‘lawer-y’. Chinese aren’t squeamish about touching on business terms early as long as it is handled in a light and non-threatening way. They probably won’t make the first move – and they definitely get spooked when things turn adversarial or are couched in legalistic, contractual language. You should talk about real issues, but look for common ground first – you can iron out differences later. Chinese prefer to start with the easy stuff – Americans sometimes like to tackle the big issues early to figure out if it’s worth it to stake in the discussion.
2) The Chinese side brought up a very significant point that may turn out to be a deal-breaker down the line. The local partner is a very real factor. There are important considerations here.
a. A local family member is going to be involved. This is a double-edged sword. The local connections are going to come in handy – in fact, Cindy may view her family connections to be her main contribution to the new partnership. The family relationship, however, is being packaged as a new partner instead of as part of Cindy’s ‘half’ of the business. This weakens Bob’s position and opens the door for corruption, mission-creep and a variety of other worst-practices. It shouldn’t kill the conversation (necessarily), but likewise – Bob shouldn’t disregard this casual statement just because he doesn’t like or understand it. This is part of the deal, and the Chinese side was honest and forthright about it. Now it is up to Bob to manage it – before it turns into a crisis.
b. This is new deal-point – and a significant one. Bob has gone from being one of two partners to being a minority shareholder. He has to digest this new information, incorporate it into a new business plan and negotiate accordingly.
Americans tend to view a family relationship as a negative to be avoided – a cost to the new business. It is the Chinese side’s responsibility – and should come out of their pocket. Chinese view the family connection as a rare commodity that they are contributing to the venture – one that will benefit the entire organization and should be borne by all beneficiaries equally.
Whichever view you take, it is ‘best practices’ to deal with this issue early. If it turns out that after meeting number 3 or 4 that the new silent partner issue ends up scuttling the deal, then no one is out much and we can walk away as friends. If they don’t deal with the issue until much later – as is the case in many US-China deals – then the costs in terms of money, time, resources and opportunity skyrockets.
c. This challenge may be best addressed with a creative business structure. American lawyers would handle this with contractual clauses and penalties – but this is like daring the Chinese side to find a way to outwit you. The best way to handle the silent partner may be structure this as a multi-phase deal, with the silent partner playing a role in only the first part. Or the answer may be a sunset clause, or Bob may want the rights to set up an independent operation in different city, or some other new option. The existence of a third partner is a structural issue – not a contractual one. When Americans try to solve guanxi problems with contractual clauses, trouble usually ensues.
The point is to ‘surface’ the key issues early – and to recognize potential deal-breakers before you have too much skin in the game. The Chinese side’s position that guanxi isn’t free and the western side is expected to pay for it. Now it is the westerner’s turn to make the decision. He can A) accept the deal structure the way it is and negotiate about the cost and terms of the new partner, B) compromise by adjusting or limiting the role of the new partner, or C) back out of the deal. Unfortunately, for many American negotiators in China there is also an F) option – ignore the real cost of the guanxi relationship until it threatens the partnership and undermines the business.
Now on Kindle: Guanxi for the Busy American. A BRIEF explanation of guanxi and relationship-building, written specifically for the overscheduled American professional. Guanxi for the Busy American