2013 U.S.-China Legal ExchangeLegal Aspects of Entrepreneurship in China

James C. ChapmanPartner, Bingham McCutchen LLP

December 9, 2013

Why China?

“It’s dynamic, messy and very different. But Silicon Valley aside, there’s no better place on earth for tech right now.”

- Kai Lukoff, TechCrunch.

“Every year another wave of “sea turtles” — Chinese who have studied or worked abroad — returns home. Many have worked with the world’s best engineers at MIT and Stanford. Many have seen firsthand how Silicon Valley works.”

- The Economist, March 2012.

“Success is where preparation meets opportunity.”

- Scott McNealy, former CEO of SUN Microsystems.

• China faces big challenges in many areas including communications, logistics, healthcare, food and agriculture, water, pollution control and abatement.

• China has a very talented and hardworking population.

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The Entrepreneurial Ecosystem Comparison — China and U.S.Venture Capital

• 2011 U.S. — $28.4 billion in 3,673 deals (PWC Coopers/NVCA Money Tree Report)

• 2012 U.S. — $26.5 billion in 3,698 deals approx. 10% decline

• 2011 China — $6.44 billion

• 2012 China — $4.94 billion significantly down from 2011 when $6.44 billion was invested. The greater Beijing area captured 28% of the investment dollars followed by Jiangsu province, Shenzhen and Shanghai.

• 2013 — through the 3rd quarter, VC firms raised only $1.62 billion and invested $1.74 billion in start-ups

• Consumer Services led the way followed by information technology and business and financial services.

Source: Dow Jones Venture Source, PWC MoneyTree Report.

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Ecosystem Differences

United States

• Culture — there is a tremendous amount of knowledge sharing, collaboration and mentoring; there is a culture of trust that encourages people with diverse skills to meet, come together and take risks together.

• Universities — most universities have good technology transfer programs

• Service Providers — attorneys, CPAs and consultants understand start-ups and are able to accommodate their needs

• Incubators and Accelerators — these are plentiful and the numbers are growing rapidly, i.e. Plug N’ Play Y-Combinator

• Ease of starting a business — can form a corporation in one day and open a bank account in one day 

• Government — little involvement

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Ecosystem Differences

China• Culture — knowledge is carefully guarded, high suspicion of copying, little

or no toleration of failure. However, those who make it big are “rock stars.”

• Universities — technology transfer programs are undeveloped or nonexistent

• Service Providers — few attorneys, CPA’s, consultants understand start-ups

• Incubators and Accelerators — are growing in number. China is building 150 start-up incubators for students returning from overseas.

• Ease of starting a business — challenging and time consuming. Opening a bank account can take months.

• Government — major involvement. Major source of funding, cheap office space, tax incentives. However, the process is tedious and time consuming, relationship driven, bureaucratic reporting requirements. In 2010, Chinese Government provided $4.16 billion in loans to new enterprises (a 65% increase over 2009).

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Start-up Challenges in China

• Pervasiveness of copycats — history of copying; copying Internet business models is easy and cheap; lack of strong IP enforcement

• Lack of experienced talent especially at the CXO level. In recent study of top engineering students, the top career choice was government (52%); in U.S., government is 5%. In China the number interested in launching or joining a start-up is 3%. In the U.S., the number is 22%.

• Cultural differences — lower appetite for risk, intolerance of failure, unwillingness to share, lack of serial entrepreneurs, inability to offer competitive salary, stock options ineffective at attracting and incentivizing employees

• Different Exit Environment — in China 69% of exits are IPOs; in the U.S. 90% of exits are M&A

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Exit Environment

IPO Market in China

• China’s stock markets declined from 2011 to 2012 and again from 2012 to 2013.

• 2012 — 46 IPOs of venture-backed companies, a major drop from the 99 venture-backed IPOs in 2011. This accounted for approximately 77% of the exits. In October 2012, The Chinese Securities Regulatory Commission suspended new listings in China. 49 venture-backed companies went public in the U.S.

• 2013 — during the first three quarters, there were only 3 IPOs of venture-backed companies in China. There were 57 in the U.S.

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Mergers and Acquisitions

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Comparison of M&A Psychology — U.S. and China

United States ChinaSpeed If do not acquire, competitors

will.Due to regulatory complexities and barriers to M&A, why acquire when one can copy?

IP Can be acquired for strategic purposes, offensive or defensive.

IP has low perceived value. Penalties for infringement are too low to deter.

Talent In war for talent, M&A allows one to acquire valuable developers, managers and entrepreneurs.

Low value, high turnover.

About Jim Chapman

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James C. ChapmanPartner

Corporate Practice Groupjames.chapman@bingham.com

T 650.849.4850

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 250 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.

James also has a significant background in international transactions, particularly dealing with China and Chinese-related companies. These transactions include both assisting Chinese companies invest and raise capital in the U.S. and helping U.S. firms make investments and operate in China. From the media industry to the pharmaceutical industry, he has been engaged in working with clients on numerous China-U.S. transactions and matters.

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