Guanxi in China ‘can be a double-edged sword’; a relationship of trust could lead one to overlook fraud or other undeclared issues

http://www.businesstimes.com.sg/companies-markets/guanxi-in-china-can-be-a-double-edged-sword

Guanxi in China ‘can be a double-edged sword’

Cai Haoxiang

29 January 2015

Business Times Singapore

A relationship of trust can paper over fraud, for example, warn due-diligence experts

DOING business in China, it is said, boils down to guanxi, or relationships. But buying a company linked to someone powerful can just as well work against you, warned participants at a symposium, who were discussing issues related to conducting due diligence in China. If the powerful backer of one’s business is caught up in an anti-corruption crackdown, the business would, at best, not grow as quickly as expected; in the worst-case scenario, the company could fold. Alternatively, one’s relationship of trust could lead one to overlook fraud or other undeclared issues.Yong Kwek Ping, chief executive of private-equity firm Inventis Investment Holdings (China), said at the Wednesday event organised by Singapore Management University’s Financial Training Institute: “Guanxi is a double-edged sword. We try to build, rather than buy relationships.

“Any business that you get because of a relationship is a red flag. We don’t want any relationships. We want to do business in a purely commercial sense.

“It’s not that we totally shun guanxi … if you build (it) up slowly by yourself, that’s perfectly OK.”

The symposium also lined up discussions, case studies and presentations by industry professionals such as risk consultants, lawyers and other corporate and private-equity investors.

Their deliberations come in a time of growing trade relationships between Singapore and China; China overtook Malaysia to become Singapore’s top trading partner last year.

Rajah & Tann partner Chia Kim Huat, the law firm’s regional head of corporate and transactional practice, cited the case of a land-development investment made in the context of a strong relationship with the local government; the investment turned out to have hidden encumbrances.

Some common due-diligence issues include the difficulty in verifying bank cash balances because of a company-bank collusion, the refusal of migrants and their employers to contribute to social security and under-declaration of taxes, he said.

Another issue is the lack of a documentation or archive system. In China’s transformation from a planned to a market economy, companies have been absorbed in chasing the bottom line, Mr Chia said.

“A lot of (documents) you ask them to produce, they don’t have. So they try to manufacture (them),” he said.

With a language and cultural barrier and a lack of trust, the Chinese can be reluctant to answer questions that they deem too private, he added. “They’re not sure what answer to give you because they want to please you. They also want to help you write a report.”

Seah Moon Ming, chairman of trade promotion agency IE Singapore, cited some rules on due diligence.

One is to understand the local business environment. New dynamics come into play when a foreign investor enters the market. A change in shareholder rules and government assistance for local shareholders could result. “Every country has to protect their own people – be aware of that,” he said.

Investors also need to get a handle on their local partner’s interests and personality. These can be difficult to figure out if the relationship has not had sufficient time to develop, he said.

Inventis’ Mr Yong, one of whose rules is to drop going into business with a company whose founder is a gambler, said he tries to find out whether this boss goes to Macau often. One way to do this is to look through his passport when settling visa matters for the boss, he suggested.

“We always invite the owner to make a trip with us somewhere, anywhere – Beijing, Singapore. We want to observe the person for three days or a week,” he said.

He added that it is common to find out that company bosses keep mistresses. “Most of our Western friends say a mistress has nothing to do with the business. For us, we will walk away,” he said. This is because mistresses do not come cheap, and one way to support a mistress is to siphon money from the company.

Rajah and Tann’s Mr Chia said mistresses and their siblings can be one recourse if a deal turns bad, because businessmen often park their wealth and other businesses under the names of those close to them.

Mr Yong added he prefers not to invest in companies run by a husband-and-wife team. He said these businesses might have family members in key positions, which can hurt the business if the marriage goes sour.

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