Beware pitfalls of joint ventures in China: report

New report sheds light on good, bad partnership models for Canadian tech companies

iStock

The economic downturn caused by the COVID-19 pandemic could allow cash-rich Canadian tech firms to grab full control of their joint ventures in China – or for Chinese interests to take over cash-poor Canadian companies, and potentially seize their core business in Canada.

That is the finding of a new report released by the China Institute at the University of Alberta, written by senior fellow – and veteran Canada-China tech sector official – Margaret McCuaig-Johnston.

The report, titled “Canadian Technology Joint Ventures in China,” puts its focus squarely on the joint venture model (JVs) required by the Chinese government for foreign companies to enter the Chinese market in certain sectors, highlighting the risk the model presents to Canadian firms who are entangled in such setups.

With the COVID-19 pandemic dramatically suppressing business activity in both China and Canada, McCuaig-Johnston said it adds new pressure to Chinese-Canadian JVs – many of which have already shown weakness in 2019 with deal cancellations and postponements stemming from a major chill in Ottawa-Beijing relations, a result of the Meng Wanzhou extradition case. Many of these JVs “would not make it” through the economic reopening, she noted.

“What remains to be seen going forward is how our Canadian technology company joint ventures in China will come through the COVID-19 pandemic,” McCuaig-Johnston wrote in the report. “It is possible that the joint venture could be kept afloat by the deeper pockets of the company in Canada. Indeed, the Canadian company might take this opportunity to position to move into a wholly foreign owned entity rather than a joint venture structure.”

The risk of the reverse situation, however, is equally high. If certain cash-poor Canadian firms are forced into financial difficulties at home, a Chinese partner overseas “may use the lack of Canadian financial resources as a breach of contract to take over the joint venture as a 100% Chinese entity.”

With many of these Chinese partner firms already a major shareholder in their Canadian counterparts, this would also open the door for the Chinese side to take over their beleaguered Canadian partners’ core operations in Canada – a possibility that needs to be countered by more stringent government regulation and oversight, according to the report.

Some of that oversight – which may be used by Canadian tech companies to stave off a takeover by a Chinese (or other foreign) partners – is already in place, McCuaig-Johnston noted.

“The Government of Canada has expressed concern about foreign takeovers of weakened Canadian companies and has introduced a new review procedure to potentially block foreign... investments that take advantage of such situations,” she said. “Further assistance could be provided by the Business Development Bank of Canada and/or Export Development Canada to provide bridge financing for the Canadian companies to get them through this difficult period.”

McCuaig-Johnston has been a vocal critic of the current JV model under which many Canadian entities operate in the Chinese market, noting the setup transfers Canadian intellectual property (IP) to Chinese manufacturers who are then able to reap the benefits of that IP, such as job gains and sales revenue from selling the final product to a third market.

In her report, McCuaig-Johnston said the problem is exacerbated because the ownership ratio of JVs in the Chinese market tends to be lopsided towards the Chinese partner firm – an imbalance that has the tendency to worsen over time as the Chinese government and Chinese companies push for more shares as a business relationship continues.

Among a list of JVs reviewed by the report, McCuaig-Johnston found four Canadian-Chinese entities in China that have ownership ratios of 90/10, 80/20, 65/35 and 60/40, all in favour of the Chinese partner firm. Another unnamed ocean technology JV had a 70/30 ownership ratio in favour of the Chinese partner.

Even the odd exceptions, the report found, were not really exceptions.

“Another joint venture was 51/49 in favour of the Canadian internet technology firm – one of the few instances which did not favour the Chinese partner,” the report said. “But when the president of the Canadian company was interviewed to find how he arrived at 51%, hoping that it might provide a good model or best practice for other Canadian firms, he said that it actually starts at 51% but ramps down over time. •