International Law Expert John J. Maalouf Part II: Early-Stage Investing in China

Yesterday, globally recognized legal expert John J. Maalouf shared his views on current investment practices in the Chinese market. Today, we tap into Maalouf’s insights on early-stage investing in China.

* Edited interview

VH: John, given the economic downturn, have you seen a shift in the advice or services people look for?

JM: We’ve seen a dramatic increase in the number of first-time entrepreneurs and startups seeking angel investors. Unfortunately, approximately 70 – 80% of these new ventures will never get off the ground, either due to a lack of funding or because they’re led by intelligent but unsophisticated first-time entrepreneurs who don’t have an experienced partner to help them develop a solid business plan.

VH: Say an investor is interested in funding a startup in China; how can Maalouf Ashford & Talbot help or what advice would you give to the investor?

JM: A significant part of the firm’s international practice is dedicated to representing U.S., European and MENA region investors in funding startup companies in China. This involves counseling investors on the practical aspects of doing business in China, including providing insights into local legal and business customs, obtaining governmental approvals, licenses and permits, performing due diligence investigations on prospective business partners, and providing numerous other services that will facilitate a foreign entity making a significant investment in China or entering into a business relationship with Chinese partners.

VH: Should angels insist an anti-dilution protection? Or do you think it should be avoided? Why?

JM: I always advise my angel investor clients to require anti-dilution protections. Without good anti-dilution provisions, a company that becomes profitable can simply issue a large number of additional shares and effectively reduce the angel investor’s ownership interest and return on investment (ROI). Angel investors frequently take significant risks; they should be entitled returns on their investments proportional to that risk.

Though anti-dilution protections are necessary, the provisions shouldn’t be too onerous or they may deter future investors. A sophisticated structure would accomplish the goal of protecting the angel’s investment while still making the company attractive to future investors.

VH: In terms of negotiation, what common provisions should angels interested in Chinese startups consider?

JM: Most importantly, an angel investor should insist on the right to appoint both the General Manager and the Managing Director of the company. Under Chinese law, these two positions have total effective control over the operations of a company.

The next most important provision is to require all disputes to be settled by binding arbitration outside of Mainland China, preferably under Rules of Arbitration of the International Chamber of Commerce in Paris, or in the alternative, in Hong Kong. In a dispute resolution procedure, most countries tend to have a natural preference to side with their own people, and China is no exception to this rule.

VH: Is there anything you’d like to add or any antidote you’d like to share?

JM: Two decades ago, virtually all of the world’s 25 largest IPO’s were listed in New York. Last year only two of the world’s 25 largest IPO’s were done in the U.S., with the rest being listed either in Hong Kong or London. Recent legislation in the U.S., such as Sarbanes-Oxley, has pushed IPO’s away from the U.S. to Hong Kong, and Hong Kong is thriving as a result. China will continue to grow in importance and economic power over the next decade. Investors who are able to get in on the ground floor will have an excellent opportunity to reap the rewards from this unprecedented economic growth.

If you’re thinking about investing in China and need some legal advice/assistance, you may contact John by visiting Maalouf Ashford & Talbot’s website listed below.

Link:

• Maalouf Ashford & Talbot, LLP