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Cross the Rubicon

Helping Your Company Sell Into, Raise Capital From, and Find Partners in Emerging Economies

Cross the Rubicon - Helping Your Company Sell Into, Raise Capital From, and Find Partners in Emerging Economies

In Today’s China Daily

Is a good article on how the country’s senior care industry is developing.  What I like about it is that it manages to balance between coverage on housing-centric solutions and home healthcare, something that not every media story does a good job.  The housing product set is much more lucrative from the point of view of institutional investors, but home healthcare is probably a more scalable and sustainable solution.  Worth the time to read in full at the China Daily site here.

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Will Americans Come to Envy China’s Healthcare?

In today’s Forbes Magazine in China, I have a column asking the question will Americans come to envy China’s healthcare?  This is designed to be a thought experiment in how China might ultimately, in time, have a better designed, more cost effective healthcare delivery model than what is currently enjoyed in the US.  I welcome your thoughts and feedback on the question here, or at the Forbes site.  Mandarin version available here.

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China Taps Private Hospitals in Overhaul – Will It Work?

Over at CNBC, my contribution on whether the existing reforms set in motion by China’s Ministry of Health will be enough to incentivize private investment in the country’s public hospital space.  A snippet from the piece:

Among the aggressive goals China has set as part of the country’s revamping of its healthcare system, is the expansion of the role for private hospitals in delivering care. The Ministry of Health has publicly stated it wants to see inpatient and outpatient visits at private, for-profit hospitals increase nationwide from 8 percent in 2012 to 20 percent by 2015.

In order to achieve this goal, China’s central government is attempting to get out of its own way: the January 2012 updated Foreign Investment Catalog moved private investment in public hospitals into the “encouraged” category, a big green light to potential investors that the country was now serious about allowing hospital management companies and private equity firms into this formerly closed segment of China’s economy.

More here.

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The Unique Human Resource Challenges in China’s Healthcare Market

Below is a cross-post from my column at today’s AsiaHealthcareBlog:

In past analysis of the senior care industry (here, here, here, here and here as just a handful of examples) we have discussed the unique challenges related to finding, training, and retaining personnel in China.  Of all the strategic challenges the senior care industry faces as it expands inside of China, navigating the human resource challenges is – I want to propose – the number one priority.  It can also be one of the easiest challenges to overlook and badly mismanage.  We already know that cultural standards relative to filial piety can change to accommodate western care models.  We already know the demographic burden in China is irreversible.  We know the Chinese government understands the problem and is working to make it easy for public/private partnerships to flourish around the country.  Here is what we do not know:  where are all the necessary “boots on the ground” going to come from?  In a country already struggling with shortfalls of doctors and nurses for its primary care system, not to mention the little clinical geriatric care that exists, where is the necessary staff going to be found?

Let me take this question one step further.  Assume that you have answered the last question and you know where your staff is going to come from.  Perhaps you have a proprietary relationship with a feeder institution like a state-run hospital or medical school.  Or, perhaps you have elected to start with people who have the most basic of skill sets and train them to your western standards.  Fine.  Great.  All good ideas.  But here is where it gets tricky:  China’s human resource (HR) market has a couple of characteristics that overlap industries.  One you need to be thinking about is what happens in an infant industry where trained staff are hard to find, but easily identifiable to your competition.  The likely outcome?  The staff you worked so hard to find and train becomes difficult to retain and, the cost of retention can quickly and very negatively impact your financial model.  In an industry with few established sustainable practices, buttoning down your HR strategy has to be a priority.  The question is, what goes into a solid HR strategy that allows you to keep the talent you have trained?

With this challenge in mind, I reached out to a number of people both inside China’s healthcare industry and others outside who have first-hand experience in HR within China.  Some asked to speak on background, which is why not everyone’s name is identified.  The latter include ex-pats who have managed operations in China for the better part of a decade, during the explosion of their industries when many of the same HR challenges the senior care industry is now facing presented themselves.  The net of these discussions has been six lessons for senior care operators, developers and investors as they build their Chinese businesses.

HR Lesson #1:  Limit the Role of the Expat

During my research of existing facilities in China that have struggled, the role of expat help brought into the Chinese senior housing development has always been front and center.  Some times, the expat help was overwhelmed early into their first overseas assignment; other times, the expats were disengaged out of the gates, many besieged by cultural differences that they felt were insurmountable; in many, finding good expat help was impossible and local expertise was brought into the facility instead.  Even with these difficulties, I have yet to speak with a player in the senior care field who does not wish they could find a local Chinese senior executive or facility manager who “knew the business.”  Absent this option (given the industry does not yet exist in China), the next hope is to find a good expat who knows China and can navigate the cultural challenges of building an organization up from scratch.  I doubt it will be possible for the senior care industry to evolve in China without poaching senior management talent from the US, Europe and Asiana to come in; however, the first lesson for new operators in this space is to intentionally limit the role of this expat.

There are a couple of reasons for this.  One is financial:  expat packages are very lucrative for the individual, and very expensive for the company.  The sooner you can transition to domestic talent, the better.  But another reason, and one we will discuss in more detail later on, is that when you set up the organization to have an expat leading it in perpetuity, it sends a message to your staff about their upward career mobility.  The top levels of your Chinese organization are symbolically powerful, and it is in your interests to have a strategy intentionally designed to move western expats out of the top back home once your operations have stabilized.  Susie Bates, a UK HR practitioner who has been operating in China for the past 30 years, has worked with the United Healthcare group and has seen first-hand the HR challenges specific to healthcare businesses in China.  On the point of limiting the role of expats, she offered this thought, “My recommendation for companies entering this newly blooming sector is that each key role is assessed against an ‘import’ scenario, and where the skillset is undeniably unavailable in China, overseas hires need to be made with the proviso that anything up to 50% of the role be set against identifying, training and developing the next generation in that role.”  In other words, if expat help is necessary, make sure everyone knows it is short-term, and that an explicit deliverable of the assignment is to find a local replacement.

HR Lesson #2:  Where to Find the Talent

Once you have landed in China, the question becomes where to find the necessary talent.  Many early entrants, in particular those that want to offer themselves up as five star, luxury brands, are going to rush to get the best doctors and nurses they can find.  Inevitably, they will find themselves knocking on the doors at the prestigious John Hopkins-Peking Union Medical College trying to find doctors and nurses coming out of this superb institution.  This is certainly a great idea, but it also comes with a lot of costs, both immediate and when considering the replacement value in a HR environment characterized by high labor mobility.  One expat in another industry (he recruited mostly chemical and mechanical engineers) offered this insight to me:  “Recruit from GOOD universities, not the BEST universities.  My favorite university in China from which to recruit really smart, hard-working and stable people?  Zhejiang University in Hangzhou.”  The temptation for an early industry, especially one looking to build a luxury brand, is to recruit from the best in class.  In his industry, that would have been less Zhejiang and more Tsinghua.  His point?  Recruit from several different schools, not all of which are where the best students go.  Find out which ones are most adaptable to your model and culture.

HR Lesson #3:  A Balanced Compensation System

The first HR lesson people want to focus on is compensation.  Let’s get the obvious out of the way first:  compensation is going to be very important.  How important?  Well, that’s difficult to say.  One expat said, “Money is important – you need to be competitive – but it doesn’t always keep top talent.”  Another “firmly believes that money and perks still talk in China.”  What seemed to be a consistent theme was to pay well, but not to try and pay the most in your industry.  One expat stated, “Pay well, but not the highest in the industry.  Give yourself room to provide token raises during the year (every six months).”

Susie offered a couple of very practical insights into compensation schemes that I found useful:  “Incentivize employees via active and visual motivational programs – tying daily operations and learning successes directly to business outcomes allows employees to realize the role they play and the outcomes (both financial and in terms of acknowledgement) mean something.  This ties into setting corporate culture early on.”  Anyone who has toured manufacturing facilities across China – especially well run ones – has seen the ways team production boards are used to visualize how the assembly line or work team is producing in relation to the company’s goals.

In addition, Susie believes bonus plans have a place in China.  She shared, “Bonus schemes that are set in place encompassing both individual and facility-wide achievement – this loops two incentives into one whereby the employees become accountable both for their own individual success, and for the success of the organization.”  Beyond bonuses, my expat sources noted offering “perks like health club memberships, a transportation allowance … and going big on Chinese New Year … do not underestimate the importance of the annual staff party.”

HR Lesson #4:  A Clear Ladder to Climb

If compensation alone is not enough, then what else matters to Chinese employees?  Everyone I spoke with consistently emphasized having a clear ladder to climb as they advanced in their career with you.  This was referenced earlier when talking about the limited role for expats in your China facility.  One friend offered that you need to “Make certain employees understand their upward career path, and always dangle the next carrot in front of them.”  Susie expanded on this, stating that in her experience, “trends show that Chinese employees no longer focus only on financial reward; today, it has become more about development, career opportunities, clear articulation of company goals and acknowledgment of (realistic) individual achievements that need to be tied directly to day-to-day operations.”  This lesson may seem so obvious that it does not need to be offered, but in my experience, this has been one of the more common frustrations Chinese employees offer as the cause for their exit.  I attribute this mistake to the tendency by western companies to assume that the large numbers of potential workers in China insulates them from having to put in place best practices like having a clear career ladder for their domestic employees.  While having a big population to draw from is accurate, the pool gets much smaller when you talk about qualified staff.  The more you want and need to hold onto existing talent in China, the more important having a clear career path available to them, against which they are being measured and managed for becomes.

HR Lesson #5:  The Training Quid pro Quo

This fifth lesson, what I call the “Training Quid pro Quo” is entirely from Susie, and I think it is genius:  “Training and development need to be provided with a documented cost both in terms of time and money; a Training Agreement, tied to the Employment Agreement, is a legally acceptable way to tie employees to fulfilling their commitment to the company against costs of education or learning fees incurred by the company to develop them.  A standard model is a ratio-tied pay-back if the employee leaves early – e.g. within 3 months of completion 90% paid back; 6 months 75%; etc. etc.”  If this is of interest, let me advise you reach out to someone like Dan Harris at ChinaLawBlog who has written extensively on Chinese employment law.

In a past blog post on the topic, Dan offered the following:  “As you will see, the Chinese employment system is based on Asian socialist and Northern European models. China’s employment law system is quite different from the U.S system. The main difference is that the U.S. is an employment at will system, which means you can terminate employees at any time for pretty much any reason. China’s system is the opposite. The Chinese system is a contract employment system. This means all employees must be engaged pursuant to a written employment contract and during the term of that contract, it is very difficult to terminate an employee. An employee can only be terminated for cause and cause must be clearly proved. This means the employer must maintain a detailed set of rules and regulations and must maintain careful discipline records to be able to establish grounds for dismissal. This whole situation makes the employment relationship and the employment documents much more adversarial than is customary in the U.S.”

HR Lesson #6:  Build the Facility as Much for Staff as Customers

Last up; build the facilities as much for your staff as your customers.  I know, I know; this seems overkill.  But just like you need to understand the needs and expectations of your potential customers – what sort of amenities, services and costs they want and are willing to bear, similar questions need to be asked relative to your staff’s needs.

Specifically, think about the location of your facility in terms of where your staff is going to be living.  If your facility is hard to get to, that is going to present a major retention problem as the industry evolves.  In a country like China where a hotel you can see from your hotel in Beijing, but that takes 45 minutes to drive to, you will want to think about transportation vouchers.  And, be creative.  What would you want if you were going to be stuck on mass transportation for up to 2 hours a day?  I bet getting a new iPod or iShuffle upon completion of an employee’s training, along with gift cards for downloads to listen to on their commute would go a long way.  Smart companies might even find a way to offer company training via podcasts with incentives for staff to listen and complete quizzes, adding further value to these incentives.

In addition, think about how to ensure the employee’s work environment is hospitable.  As an operator in the west, you know how trying caring for elderly patients can be – both physically and mentally.  Make sure this wear and tear on the individual is reflected in how you take care of the common employee spaces.  Offer them ways to relax, unwind and socialize and to do so in an environment that is similar to the level of sophistication and finish you provide your customers.

None of these lessons are rocket science, but poorly constructed HR practices have governed the ability of other infant industries in China to expand.  Some times this has meant Chinese competitors have been able to innovate and work within their culture after seeing the mistakes of their western counterparts.  Other times it has simply resulted in industries that struggle to grow as quickly as they could if HR was not the sector’s primary bottleneck.  I would imagine that as this industry continues to move forward, we will see many early entrants struggle to get and stay at scale primarily due to HR problems versus the market’s acceptance of the products or costs for the services rendered.  Of all the problems the senior care industry would do well to put behind it, crafting strong and balanced HR practices may be the most important to resolve.

By:  Benjamin Shobert, bshobert (at) rubiconstrategygroup.com, +206-652-3572

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Fortune Magazine Covers Senior Care in China

The September issue of Fortune Magazine in China features retirement issues – from financial services to senior living analysis – from the point of view of potential Chinese customers.  In the magazine, I have a feature article outlining the key challenges and opportunities Western operators must meet if they are going to be successful expanding into China.  The full article can be read here.  A big thank you to Cole Wright with Merrill Gardens in China as well as Joe Christian at Harvard for participating as sources in my column.  Their input was, as always, deeply appreciated and highly valued.

The article was slightly different than others in that it was written with an eye towards educating potential Chinese developers and customers as they entertain senior housing options either as potential customers or investors.  From the article:

The second mistake Chinese developers must avoid is under-estimating the complexity of senior housing as a business.  In contrast to traditional commercial and residential real estate, developing senior care facilities – including senior housing – is more involved.  Developers who view senior housing as simply another way to unlock the value of their existing real estate are going to be disappointed.  Those that survive this disappointment will learn and go on to build successful senior care developments; however, like what happened in the US during the early 80s, it is possible some elderly Chinese will move into newly built senior care facilities only to find that the businesses behind these operations run out of money because the developer did not understand the lifetime costs of running a senior care facility.

The full article can be read here.

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Follow Me @ www.ContextChina.com

I’ll be writing for a new Seattle-based start-up, contextChina, offering insights on business challenges and policy issues related to China.  For now, my first column on why start-ups head to China can be read here.

From the column:

At least four factors drive local start-ups to China:  a need to sell into China’s growing economy, a desire to develop technology within the country, the hope they can grow more quickly there than they could in the U.S., and the belief they can raise capital from Chinese investors.  In each of these cases, understanding why local start-ups have reached out to China speaks volumes about the opportunities and risks these firms must understand in order to be successful.

Read the entire column here.

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Don’t Expect India to Lead (Yet) …

Right now, as the global economy looks increasingly fragile, people are eager to find reason to be optimistic because of what is hopefully happening in other BRIC nations.  This in part explains much of the recent PR around Indonesia as a potential replacement for India in the BRIC acronym.  One country that many are hopeful about is India, even though the last year has not been kind to the country.  Inflation, GDP slow-down, political turmoil, uncertainty over necessary FDI reforms, and now a brutal power outage.

CNBC’s article on the recent power outages did a good job capturing why this is such a problem for India and why for all the great good the county could do for the global economy, it just isn’t yet ready for this:

Thomas Byrne, senior vice president at Moody’s Investors Service, said the recent blackouts may hinder new investment into India.

“This (the recent power crisis) will have a chilling effect on whether new people want to take advantage of India’s long-term growth potential,” he said.

Foreign direct investment into India has been in the decline, falling 38 percent over April to May, compared to the same period last year, with regulatory uncertainty and policy flip-flops deterring investors.

China certainly has its own share of problems in the area of its electrical grid, but a problem of this magnitude at this stage in India’s development isn’t something that can be overlooked.  The country’s vibrant democracy has to do more than just add color to the global conversation about the role of democracy in economic reforms, now it has to prove that its model is capable of identifying problems and coordinating actions to deal with the country’s problems.

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Due Diligence for Senior Housing Operators in China

Note:  This is cross-posted from my blog today over at AsiaHealthcareBlog:

As North American senior care operators expand into China, one of the first decisions they will make – who to select as their real estate partner – is also likely to be one of the most critical.  This would always be a pivotal decision entering any foreign market, but in the midst of very specific concerns related to the financial viability of well-known Chinese real estate developers during what appears to be a massive slowdown in China’s real estate market, understanding the condition of potential developer partners is more important than ever.

A word on what is going on in China’s real estate sector is, unfortunately, a necessary detour.  Readers may be familiar with the story of Chinese property developer China Evergrande, one of the ten largest property developers in the country.  For those not familiar with the backstory, reading the following from China Economic Review will help capture the sort of downside risk many fear is endemic with China’s property developers:

“Property developer China Evergrande (0333.HKG) said it was considering legal action against Citron Research after the short-seller group accused Evergrande of financial irregularity and bribery, Reuters reported. Evergrande’s shares fell more than 4% and its bonds dropped 1.3 basis points on Friday, following a 11.4% fall in the company’s stock on Thursday that wiped out about US$1 billion of the firm’s market capitalization. Evergrande Chairman Hui Ka Yan, who owns 63% of the company, denied allegations that it was insolvent in a conference call on Thursday, saying the company has RMB13 billion (US$2 billion) of cash on hand, sufficient to cover its operations. In a note on Friday, Barclays Capital said there was “still no clarity on whether the accusations are true or false.”

 

In my mind the absolute best real estate analyst, and also one of the best at explaining the banking system and overall economy in China, is for my money Patrick Chovanec.  Writing about the Evergrande situation, he had this to say about the concerns it brings up for him:

“… They do resonate with me, because they resemble or are connected to many of the systemic risks I see building up across China’s property, trust, and banking sectors.  The big question I have been asking myself all Spring — with so much developer debt coming due, and with their cash flow so visibly impaired by the property downturn — is why we’ve hardly seen any Chinese developers (and the trusts that have fueled their building binge) go bust.  The hidden losses alleged by Citron may help answer that question, and the explanation is unlikely to be limited to one ‘bad actor.’  Like the losses that have been brushed under the rug in the Zhongdan Guarantee fiasco, they are just one piece in a much bigger and interconnected mosaic. “

 

I’ll leave it to the readers to pursue stories about China’s ghost cities for further background on how deep the problem may go, as well as two other what I consider “essential” reads on the condition of China’s real estate, both by Chovanec.  The first was published in December 2011 by Foreign Affairs and the second is from May 2012 on his blog.  I really encourage senior care operators who are serious about understanding the pressures the overall real estate sector is under to take the time to read these both.  The point is to understand the downside risk at this particular moment in time within China specific to real estate developers is unique.

If this all has your attention, good, it should.  Where due diligence about the financial condition of a potential real estate partner in China was always going to be important, it just became exponentially more so.  The problem is, simply put, completing due diligence in China is not a science – it’s an art.  Unlike in developed economies, rating agencies like D&B and S&P have very, very, very little light to shed on the financial health of a potential partner.  So doing this well is an essential part of your market entry work.

Having said this all, acknowledging the art still means we have to distill the practice of competent due diligence down to a set of principles that can be followed.  The following seven are a combination of my own research as well as an extended conversation I had with a good friend, Kent Kedl, who runs Control Risks in China.  Control Risks is one of the pre-eminent due diligence firms around the world, and their China practice is focused on strategic due diligence.  Kent is one of the original China hands; he is into his fourth decade living in China and to my mind one of the best in the business.  Prior to running Control Risks in China he was a Principal with Technomic Asia, a China consulting firm that played essential roles in helping many Fortune 500 MNCs first enter China, a body of work that firm continues to build on today.  What you will recognize in each of these is the highly intangible aspect of what each of the lessons stress.  If this makes you uncomfortable that’s one thing, but none of this should stop you from developing a China strategy.  Perhaps the right way to think about all these “intangibles” is to make you careful, diligent and patient.

Due Diligence Lesson #1:  What they have already done is interesting; what they’re doing now is criticalLet me expand on this a bit.  Keep in mind that many potential real estate partners in China have been amazingly successful over the last thirty years by pursuing a strategy of “build it and they will come.”  So yes, and most obviously, you need to understand what they have built and the models they have used to finance and operate their developments; however, because this particular moment in time is potentially fraught with downside risk specific to China’s real estate sector, it is absolutely essential to understand what they are building today, and the offers they are making potential customers at these developments.

Here is the sort of due diligence you will want to do.  Get a list of the developments they are currently marketing and selling.  Get them to tell you about their pricing scheme, when they will be ready, etc., etc.  Then, as the firm Muddy Waters so eloquently puts it, “approach them the way a potential customer would.”  With the information about the current developments they are selling firmly in hand, send out your Chinese associates to approach these developments as potential customers, and then have them ask the same questions.

One thing I can almost promise you will come of this is eye-watering discounts at many developments.  I can personally vouch for multiple developments I have been at over the last quarter of 2012 around China where very nice condo and other residential housing was going for up to 50% discount from list.  A great anecdote about this can be read over at ChinaLawBlog.  Massive discounts are not the sign of a healthy developer.  That’s someone focused on cash flow over profitability and sustainability, and it’s happening all across the country.  If you get a Chinese associate posing as a potential buyer to visit the majority of your potential partners’ current developments and you see massive discounts, be careful.

None of this is to suggest that looking at what they have already built isn’t important.  You do want to understand what sort of operating models they have found to be best suited for their owners and management team.  Do they stay involved with a property, or do they look for an early exit?  Do they have experience building for, or staying engaged with, an operating model that has a hospitality or healthcare element to it?  If so, they are more likely to understand the longer-term commitment many senior care operators from North America will need.  In addition, it is important to understand whether the financial structures of their deals have materially changed over the last several years (i.e. are they using more debt than equity, and if so, where is the debt coming from, and what is the form of debt they are taking on?).  Trends, themes and narratives from each of these questions are deep veins to explore, and in many cases will illuminate a lot about the financial condition of a potential partner.

Due Diligence Lesson #2:  What did they earn, versus whom they know.  Let’s get the obvious out of the way:  China is a land where transactions close as much because of guanxi (relationships) as they do underlying commercial sensibility.  Consequently, you need a real estate partner with good guanxi.  But what you need to understand is how they came about getting this.  Are they just well connected, or do they have a high ability to execute a business plan?  On this point, Kent added, “You want to be able to tell the story of this guy:  How did he get to where he got?  In his background is a person – or persons – who this person knows who got him to where he is today.  You need to know what he has done in the past – not just the ones he puts on the website or presentation – but what he actually did in each one of his projects.  What were they given because of guanxi, versus what they earned because they understood the business?”

Think about this as a combination of relationship mapping and really understanding the narrative of their path to success.  None of this is mutually exclusive.  A potential partner that has been successful likely has great guanxi, and may be (and probably is) well connected with the local government.  What you’re looking for is more – more than just guanxi.  Because the concept of guanxi is one of the first ones most early entrants to China grab ahold of mentally, it is one of the ideas that people tend to look for and see – whether the conclusions they come to because of this are appropriate or not.  Since guanxi is this highly informal concept with very formal implications, it is important to understand not just the guanxi they have, but how they built the relationship network they have today.  Look for competence tied to connections, and if the option exists to get great connections over competence, that might not be the right trade at this particular moment.

Due Diligence Lesson #3:  Reputational Due Diligence.  So what does “more” than just guanxi actually look like?  Here we need to introduce the idea of reputational due diligence.  Kent first introduced me to this phrase when I was researching a deal in Moberly, Missouri with a Chinese company called Mamtek.  To make a long story short, the city of Moberly stepped up to finance a deal for a new artificial sweetener plant to be built in their city.  It should have been a great example of Chinese investment into the US, but it fell apart, leaving the city holding the bag.  The city made a series of mistakes, not least of which was capitalizing much of the deal themselves; however, there was also a problem with a fundamental lack of due diligence.  I was researching the story and reached out to Kent who raised the idea of “reputational due diligence.”  Had it been done with Mamtek, the deal would likely never have moved forward.

Related to the real estate sector in China, Kent suggested that you want to understand, “what is their reputation around what they have done.  In the US we do things like credit checks and litigation review, but in China so much is not in the public record or any government files and so much is just in the local community, where these people grew up and have become successful.   You need to go talk to their partners and suppliers to find out who they are.”  You are extremely unlikely to find a financial report showing your potential partner is deeply in arrears with his vendors, but his vendors will tell you that.  How?  You can obviously hire a company like Control Risks who can deftly handle these questions.  You can also use your Chinese associates to interview key vendors in the real estate developers’ supply chain under the auspices of your desire to understand the whole picture.  I can’t tell you the number of times in supply chain projects this sort of information has easily presented itself over the ubiquitous long business lunch or dinner.  It’s out there for the getting, but you have to be thinking creatively and put yourself in a position to ask the question indirectly.

Due Diligence Lesson #4:  Take any publicly available information with a grain of salt.  I have already made this point, but it bears repeating:  put very, very, very little credibility into the information you can access through rating agencies.  If you pull back the layers to the Evergrande story, one of the obvious lessons is that even documents prepared for a publicly listed company cannot be trusted.  If you have been watching the numerous stories coming out related to the crisis North American accounting firms are facing in China, one of the most obvious points is that even the absolute best accounting firms in the world – those that should know where to look to find half-truths and under-stated liabilities – are not able to do so effectively in China.

Due Diligence Lesson #5:  A network of competitors.  Obviously information that comes from a competitor has to be taken with a grain of salt.  But, what you will get as you sit down and talk to competitors, obviously with the objective of understanding whether they might be good fits in their own right, is a sense of the market.  Talk to 5-10 potential real estate developers in a particular city and a narrative will begin to evolve, one that will have a couple of key points about the challenges they are all facing, and more than likely themes about particular companies.  Again, look for themes, common threads, general unifying anecdotes that seem to shed light on your potential partner.  If none of them cause you to worry and seem pretty standard for how competitors view and talk about one another, then check that box and move on.

Due Diligence Lesson #6:  Get the government involved in your deal.  This may seem counter-intuitive, but it is again a lesson that comes out of the Mamtek deal.  As important as the Chinese concept of guanxi is, the role of “face” is as much so.  Consequently, this is something you can use to your advantage.  As you are evaluating potential partners, get feedback from the municipal government officials and get them engaged in how the deal is coming together.  Some of this will happen organically for you as you get the necessary commercial licenses from the Bureau of Civil Affairs and healthcare approvals at the Ministry of Health; however, do not allow this to be the only way you get the government involved.  Early on, make a point of building your own guanxi with local government officials.  Get them to become a stakeholder in your investment, admittedly in an indirect fashion (a hat-tip here to Malcolm Ridell over at China Debate who keyed me onto this concept as it could have been used by Moberly).  What this will do is create another person who stands to lose face if the right deal doesn’t come together.  Consequently, you have another individual who is going to be invested in making sure you get paired off with the right partner and that the underlying problems (regulatory approvals, land rights, etc.) are addressed.

Due Diligence Lesson #7:  Never take land rights for given.  Many much larger MNCs have been fooled by bad due diligence over land rights. Companies who thought they had properly secured the necessary land rights have found, some well into a build-out, that the land had not been properly purchased.  This is likely to become more of an issue given the central role property rights hold as one the top grievances by rural Chinese.  Among the many causes of social discontent within the country are China’s land right policies, or what may be more accurately termed China’s land taking policies.  Knowing for sure that your development partner actually has the necessary land rights is something you cannot take for granted.  You need to make sure a local lawyer has properly evaluated this.  The process for doing this is fairly involved and laborious, and is the sort of work only a local lawyer will be able to do for you.

On this point Kent shared, “while you own the building on the land, there are two commercial relationships you can have with the land.  You can lease the land use rights or you can own the land use rights.  You need to find out the commercial relationship the developer has with the land.  Specifically, if he doesn’t, who does – does he just lease them?  If he owns them it is greater protection against eminent domain should the government decide to build a highway through your development.  Does the person you are dealing with own the land use rights or represent someone who does?”  Again, this is information the developer is more than likely not going to tell you himself.  You should ask, and file his answer away as a test of his integrity once your own due diligence confirms or denies this, but take his answer with that in mind.  The only way to confirm land use rights is to hire a local lawyer to review the local files, chops and registrations.

On this point, I think it is worthwhile to elucidate in a bit more detail exactly what goes into this sort of local examination.  My friend Dan Harris over at ChinaLawBlog has written extensively on the question of evaluating company seals and chops.  Here is what he has to say on the matter:

“When asked how they go about confirming the validity of a seal, the lawyers told me that ‘you have to go the town where the company is located.’ Once there, you then have to determine if the seal is registered. Often the seal is not registered as registration of seals is not mandatory in China. Then you inspect various documents filed with the local authorities to determine if the same seal was used on those documents. If the seal is registered, or if the same seal was used on all company documents filed with the local authorities, you know that the seal is valid.”

It may seem un-necessary, but it is the sort of basic due diligence that you will never regret engaging, especially if you understand how tenuous property rights are in China, and how common it is for land issues to reverse developments that previously had the green light.

These seven due diligence practices constitute basic principles that should go into how you evaluate potential real estate partners.  They are, admittedly, very intangible.  Many are inexorably inter-related and may seem counter-intuitive, none more so than how guanxi is both necessary and yet not sufficient.  As such, if this all makes you a little uncomfortable, that is perfectly normal.  The challenge of due diligence in China is being able to use reputational factors in place of the more empirical means we have of evaluating potential partners in developed economies.  Getting good at this sort of due diligence is part of knowing the right questions to ask in the first place, and it is essential you have someone working with you who at least knows the right questions.

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