HanHai Investment Presentation - March 13 2015 - J Chapman

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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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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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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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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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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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 Challenge
Characteristics 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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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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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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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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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
16

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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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.
21

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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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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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
26

Key Issues in Letters of Intent
• Price
• Structure
• Target Closing
• Employees
• Confidentiality
• Exclusivity
27

Due Diligence Process – Key Areas
• Financial
• Tax
• Legal
• Human Resources
• Intellectual Property
• Environmental
• Other
28

Due Diligence
“Where are the bodies buried?”
Key Problem Areas
1. 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
34

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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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. Chapman
Silicon Valley
tel. +1.650.849.4850
fax. +1.650.843.4001
email. james.chapman@morganlewis.com

© Morgan, Lewis & Bockius LLP 37
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HanHai Investment Presentation - March 13 2015 - J Chapman

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