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www.morganlewis.com
Hanhai Investment
Business Innovation and Cross Border Mergers and Acquisitions
James C. Chapman, Partner, Morgan Lewis & Bockius
March 13, 2015
Entrepreneurship Development Program of Nanyang Technological University, Singapore
© Morgan, Lewis & Bockius LLP
Entrepreneurialism 101
The term “Entrepreneur” is very popular. With the proliferation of start-up companies and large pools of capital available, many people want to be entrepreneurs. However, not everyone can meet the demands of starting a new company. Without doubt, an entrepreneur must understand the market, opportunity, the problem to be solved, growth potential, current methodologies, market entry strategies, distribution channels and capital requirements among many other things. However, there are a number of deeper more fundamental characteristics one must possess to be a successful entrepreneur.
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Entrepreneurialism 101
1. An entrepreneur must understand that he or she can solve a problem better than other people.– They are often frustrated in conventional work environments.
– This frustration is a key motivating factor causing them to start a company.
– Bureaucracy is usually an obstacle but it is the inability of others to recognize the entrepreneur’s visionary ability and unique ability to solve problems that spurs them toward their own company.
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Entrepreneurialism 101
2. An entrepreneur must be driven.– True entrepreneurs possess an unparalleled drive to pursue
their vision.
– Obstacles are plentiful whether they be technical, financial or human related.
– “Being an entrepreneur is like crawling across broken glass, it is difficult, painful and requires a lot of sacrifice.
– An entrepreneur spends 5-7 years working 14-18 hours a day.
– The success of the business is the primary goal no distractions or conflicts of interest.
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Entrepreneurialism 101
3. An entrepreneur must be willing to do what is required.– Every start-up company lacks resources
– As a result, the entrepreneur must be willing to do everything from raise capital to empty the waste basket.
– To entrepreneurs, the title “CEO” means the person who does everything as opposed the “boss”.
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© Morgan, Lewis & Bockius LLP
Entrepreneurialism 101
4. The entrepreneur must have “guts.”– The entrepreneur must be able to withstand the tremendous
pressures involved with a start-up.
– There is never enough resources, often the company may seem unable to make payroll and the big contract is often just out of reach.
– It takes a lot to mortgage one’s house. run up the credits cards, borrow money from friends and family.
– A gutsy entrepreneur is one who keeps going when everyone else has given up.
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Entrepreneurialism 101
5. An entrepreneur must have the right combination of ego and flexibility.– Must have passion regarding the vision but must be flexible and
open-minded as well.
– Must be able to listen and accept coaching.
– The strategy for implementing the vision will change and evolve.
– Cannot let ego cause “tunnel vision”.
– Must be committed to success and overcome rather than rationalize problems.
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Leadership ChallengeCharacteristics of Successful CEO’s of Start-up Companies
1. Fierce Sense of Ownership – The CEO takes ownership for the idea behind the company and the company’s future. The CEO is not looking for validation or support for the vision.
2. Strong Domain Knowledge – The CEO has knowledge of the technology or market that others do not have.
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Leadership ChallengeCharacteristics of Successful CEO’s of Start-up Companies
3. Great Internal Compass – The CEO guides the company through difficulties and has a strong sense of purpose.
4. Projects High Energy and a Sense of Robust Health –
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Leadership ChallengeCharacteristics of Successful CEO’s of Start-up Companies
5. Strong and Nimble Intellect – The CEO has a good combination of intellectual power, “street smarts” and mental agility.
6. Decisive – The CEO is always working toward a decision and does not get bogged down in minutiae.
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Leadership ChallengeCharacteristics of Successful CEO’s of Start-up Companies
7. High Emotional IQ – The CEO has passion, projects excitement, enthusiasm and joy. The CEO also knows what he does not know.
8. Can Tell a Great Story – The CEO communicates a picture of a world that is better because of the company’s product or service
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Leadership ChallengeCharacteristics of Successful CEO’s of Start-up Companies
9. Strong Integrity, Values and Character – The CEO inspires trust and maintains it.
10.Has a Passion for Learning - The CEO has insatiable curiosity and inspires others to challenge themselves.
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The Lean Start-Up
• “75% of startups fail.” Shikhar Ghosh, Harvard Business School
Methodology• Favors experimentation over elaborate planning, customer feedback
over intuition and iterative design over traditional robust design upfront.
Foundation• The Lean Start-up Theory rejects the idea that it is possible to figure
out most of the unknowns of a business in advance.• Business plans rarely survive the first contact with customers.• Five-year planning is a waste of time.• Start-ups are not smaller versions of large companies.
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Key Principles
1. Entrepreneurs start with a series of untested hypotheses. These include how the start-up creates value for itself and its customers.
2. Customer development is key. Before a product is designed or the founders should ask potential customers and users for feedback on all elements such as business model, product features, pricing, distribution channels. The emphasis is on nimbleness and speed.
– New ventures create “minimally viable product”, quickly get customer feedback and revise.
3. Agile Development - Products are developed incrementally.
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What Every Entrepreneur Should Know
Cross Border Mergers and Acquisitions
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Key Rules for M&A in China
Rule #1 – “In China, everything is possible but nothing is easy”
Rule #2 – See Rule #1
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Important Factors for Deal Success in the US and China
• Well-executed integration plan• Correct valuation/deal price• Effective due diligence• Positive economic conditions
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Factors Driving M&A Activity in China
• Continued growth in China• Desire of foreign companies to enter the China market• Desire for foreign companies to gain market share• Consolidation of key industries – auto parts, cement and
metals• Activity in high technology, clean technology and sectors
oriented toward Chinese consumer spending
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Goals of Chinese Companies
• Chinese companies desire technology, managerial experience and new markets
• Chinese companies offer resources, relationships and knowledge on how to succeed in the domestic market characterized by
– Intense competition
– Bureaucratic complexity
– Diverse regulations
– Varied consumer preferences
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Roadmap for Completing a Deal
Acquisition of a Chinese company is a long, multi-step process often taking 18 months to complete.
Critical Steps:
1.Selection of Target– Substantial research for potential targets must be conducted including
governmental policies in the target industry.
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Roadmap for Completing a Deal
2. Relationship Building
– From the initial contact, foreign buyers should work to establish a friendly relationship with the selected Chinese target. Foreign buyers are encouraged to not only do business with Chinese partner from a pure money-making perspective, but also work on “jiao pengyou” or making true friends.
– Role of “mian zi” or “face” - Very important and the Chinese feel embarrassed in taking advantage of a true friend. Foreigners are fair game.
– Trust - A good relationship helps a foreign buyer win the Chinese target’s trust (to the extent possible), which makes business in China much easier.
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Roadmap for Completing a Deal
3. Preliminary Due Diligence – Target’s value and market positions. Request and analyze information
from the Chinese target and comparing such information with the buyer’s own independent research.
4. Letter of Intent
– In Chinese deals, the letter of intent should be more detailed than in U.S. deals.
5. Complete Financial and Operational Due Diligence
– A thorough due diligence includes, but not limited to the following (which is not intended to be an exhaustive list): (i) Assessing Financial Statements and Audits; (ii) Taxes and Filings; and (iii) Human Resources.
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Roadmap for Completing a Deal
6. Complete Legal Due Diligence
7. Acquisition Agreement and Related Documents – The period starting from the execution of relevant acquisition
agreements to the closing of the deal is a sensitive stage for both parties. At this stage, the foreign buyer is not the legal owner of the target and has no control over the target’s business operation as the proposed deal is pending approval of the applicable Chinese government authorities.
8. Government Approvals– Unlike the United States, Chinese government agencies are active in
every transaction. Every acquisition must go through various examination and approval procedures to consummate the deal.
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Roadmap for Completing a Deal
9. Co-Management of the Target’s Corporate Seals– The procurement of the government approvals takes time. Buyer
should consider negotiating a “co-management” agreement whereby the target will need the agreement of both parties to use the target’s corporate seals.
10. Closing– After the documents are signed and government approvals obtained,
the parties may finally close the transaction.
11. Conversion of the Chinese Target to an FIE– After the closing, the target will be converted to either a wholly
foreign owned enterprise or an equity joint venture.
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Letters of Intent
• Determine if the parties can agree on the structure and business points of a transaction prior to spending substantial amounts of time, energy and money conducting due diligence and preparing formal documentation.
• Provide a summary of the proposed business arrangement;
• Fix a timetable for completing the transaction (which can be particularly helpful in complex transactions);
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Letters of Intent
• Identify the various contracts included in the transaction such as employment or consulting agreements, license agreements or severance arrangements; and
• Identify conditions to closing the transaction such as obtaining financing and buyers due diligence review.
• Measure of commitment; • Psychological effect on future negotiations
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Key Issues in Letters of Intent
• Price• Structure• Target Closing• Employees• Confidentiality• Exclusivity
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Due Diligence Process – Key Areas
• Financial• Tax• Legal• Human Resources• Intellectual Property• Environmental• Other
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Due Diligence“Where are the bodies buried?”
Key Problem Areas1. Ownership of the Target – practice of holding ownership in the
names of others.
2. Financial records – 2 or 3 sets of books.
3. Permits/licenses – many companies operate outside of the scope of their permits.
4. Ownership of Assets – often complex, no clear trail of ownership.
5. Tax payments – often negotiated, underpayment is the rule.
6. Bribery/illicit payments – are the rule not the exception.
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Due Diligence Process
1. Background checks of the company, key owners and management – Usually conducted by a third party investigation firm.
2. Management Questionnaires –
3. Facility Visits –
4. Meetings/conversations with third parties – tax authorities and other governmental officials, customers, suppliers, current or former “partners”.
5. In-depth financial review –
6. IP Review – IP audit
7. Analysis of product development -
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The Acquisition Agreement Key Limitations
1. Structure of the Transaction –
2. Structure of the Purchase Price – – Cash
– Equity – Must be freely traded on an overseas exchange and meet other requirements; requires MOFCOM
approval
– Earn-out –Difficult to use, rules require payment of purchase price within three months, can be extended to one year; requires MOFCOM approval.
– Seller Financing/ Notes – difficult to use.
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The Acquisition Agreement Key Limitations
3. Indemnification and Holdbacks – Similar challenges to earnouts
4. Appraisal – Value of target’s equity or assets set by an appraisal firm located in China.
5. Non-competition – Can be attached to employment agreement; limited to two year term; after expiration of employment agreement, buyer must pay compensation.
6. Governing Law – According to PRC law, cross-border acquisitions with a target in China may only be governed by Chinese law.
7. Dispute Resolution – China is part of the New York Convention which allows the enforcement of foreign arbitration awards in China. Hong Kong International Arbitration Center, Singapore International Arbitration Center are preferred forums.
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Obstacles to Deals
The M&A landscape in China is full of obstacles including:– The laws and regulations are inconsistent and unclear.
– Chinese companies lack transparency and due diligence is challenging.
– The governmental examination and approval process is complicated and time-consuming.
– Strict foreign currency control.
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Deal Structures
• Asset Purchase• Stock Purchase• Merger
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Key Challenges and Potential “Deal Breakers”
In evaluating potential Chinese targets, there are many challenges.
1. Lack of integrity of the target’s management.
2. The inability to establish clear title to assets.
3. High expectations of value.
4. Unreliability of financial statements, lax regulatory compliance.
5. Ownership of the company itself.
6. Complex integration.
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© Morgan, Lewis & Bockius LLP
Our Team
James C. Chapman focuses his practice on securities law, venture capital, mergers and acquisitions, and international business transactions. He has more than 25 years experience in corporate and securities law and has been involved in over 300 mergers, acquisitions and financing transactions. These transactions have included public offerings, private placements, debt financings, venture capital transactions, stock sales, asset sales, mergers, reorganizations and recapitalizations. Jim also has a significant background in international transactions, particularly dealing with China and Chinese-related companies. These transactions include both assisting Chinese companies investing and raising capital in the U.S. and helping U.S. firms acquire Chinese companies, make investments, operate in China and resolve disputes. From the media industry to the pharmaceutical industry, he has been engaged in working with clients on numerous China-U.S. transactions for 15 years.
Jim is also the author of over 50 articles including “Trade Secret Protection in China: A Perspective from China and Hong Kong,” Association of Corporate Counsel (January 2013); “Mergers and Acquisitions - What Every CEO Should Know,” ExecuSense (October 2012); “Joint Ventures in China: What Every CEO Should Know,” Law360 (June 20, 2012); Eight Trends in Venture Capital 2012,” Law360 (June 4, 2012); Co-author, “Cleantech Patents and Investment: What to Expect in 2012,” Law360 (Feb. 29, 2012); Co-author, “Clean Technology Innovation in China,” Eye on China - (February 2012); Co-author, “Clean Technology Innovation in China,” Top Capital Magazine (October 2011); Co-author, “Mergers and Acquisitions in China Part II: Anatomy of a Deal in the Middle Kingdom,” Corporate Finance Review (November-December 2011); “Tumultuous Times: Trends in Venture Capital,” Daily Journal (Oct. 14, 2011); Co-author, “Mergers and Acquisitions in China Part I: Anatomy of Deal in the Middle Kingdom,” Corporate Finance Review (September-October 2011); “Brave New World: Technology Transfer to China,” The Licensing Journal, Vol. 31, No. 7 (August 2011); “JIAO PENGYOU - A Guide for Successful Business Relationships in China,” AMA’s Leader’s Edge (March 2011); Co-author, “Mergers and Acquisitions in China: Current Trends and Challenges in the Middle Kingdom,” The Association for Corporate Growth (January 2011); “Intellectual Property Protection in China - Building the Proper Foundation,” (May 2009); “M&A In China - Ten Strategies for Successful Cross-Border Transactions,” Asian Counsel (September 2008); and “The Road to China: Ten Key Lessons for Doing Business in China,” The Licensing Journal, Vol. 28, No. 7 (August 2008).
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James C. ChapmanSilicon Valleytel. +1.650.849.4850fax. +1.650.843.4001email. [email protected]
© Morgan, Lewis & Bockius LLP 37
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