Entering China By Traveling Light

Welcome everyone to another edition of my China Tech Law Newsletter.?Today I’m going to talk about what I’m seeing in the market lately.?

The 2+ month hard lockdown in Shanghai and sporadic lockdowns in other cities was a big disruption to a lot of businesses here.?Things are slowly starting to get more and more back to normal, and macro-economic conditions are still solid even with ongoing restrictions in place.?E-commerce is flowing again.?While offline retail is still not fully operational, it is expected?to come back over time.

Throughout all of this, one thing I’ve noticed in particular is virtually no slowdown or hiccup in new SaaS companies coming here.?Nor existing clients I work with questioning whether their market entry plans still make sense.?And its not too surprising when I think about it.?Many of the clients I’m working with these days are not looking or even needing to make huge capital or HR commitments to their new business in China.?Many companies have already come and made those investments by now. Instead, asset-light companies whose primary business, for example,?is a cloud-based software application have relatively limited risks of failure but still plenty of upside here.?

These are the types of companies I’ve written about before . “Boring” companies doing things on supply chain, cybersecurity, CRM, or other enterprise functions helping the back office of their clients here or with China as part of a global solution.?In other words, many come over to continue servicing their multinational clients locally.

Most SaaS clients are taking this approach:

(1)?Have a Chinese or multinational anchor customer or customers asking them to come offer their solution in China for performance (software running on a local server inside the Great Firewall) and invoicing (in local RMB with fapiao tax receipt) reasons.

(2)?Some initial hesitation hearing all sorts of stories of how daunting that is, but eventually repeating the line I hear time and time again, “we need to be in China”.

(3)?Reaching out to us or a more general go-to-market partner first.

(4)?Understanding whether they need an ICP or other VATS license (see earlier post ).

(5)?Understanding how sensitive the data is they will be working with here (see earlier post )

(6)?Combining 4 + 5 to evaluate corporate structural options (see earlier post )

(7)?Go/No-Go decision

Okay, let's take these points in turn:?

(1)?Having a Chinese anchor customer

I see this time and time again, and this is highly recommended.?There are more customers in China pushing their suppliers to operate inside the firewall for speed and user experience.?CDN services which help speed a connection through the firewall from outside of China are sometimes an acceptable alternative from a user experience perspective, but ultimately put a lot of burden on your customers for data management and compliance as they are considered the data exporters under all data regulations here instead of the SaaS vendor.

(2)?We need to be in China.

As I summed up in this recent podcast on SupChina - there are no shortages of challenges here, and its not for the faint of heart. But despite the time, costs, trade wars, concerns on IP, etc., the market size is often too big to ignore. Especially for enterprise SaaS which can come here on that asset light approach.

(3)?Reaching out.

We are happy to work with clients directly but we often find Go-To-Market partners really do provide an incredible amount of value presenting clients with the total business picture and doing, for example, business due diligence on other partners and market opportunities here.

(4) ICP/VATS Licenses.?

We find clients often taking more and more of a staged approach (e.g. just setting up a simple WFOE first), and more and more accepting the risk that their business can fly under the radar or make a case they don’t need a VATS license until they get up to scale.

(5)?Data Compliance.

Restrictions on transfer/export and considerations for local storage of data which I’ve written about here and here can dictate a lot of the corporate structure and costs.?An offshore structure is lighter but does switch some data and other regulatory compliance burden to your customer, and you need to be involved still to help them as much as possible.? Happy customer, good business.

You need to also be well informed how you will be working with your customers or a local subsidiary if you set one up. A lot of people start with the strong presumption, I don't want to have the burden of any of my own people on the ground in China. I don’t want to find and train up local tech support people in-house, at least not yet.?

That’s fine but remember, for example, that seemingly mundane things like remote access to the data is considered a de facto export under data regulations (and all the consents and other burdens I’ve written about earlier) and your technical support team back home can still create local data compliance challenges in that sense.

So eventually you’re going to make your life (and your client's life) easier running a copy of your core software here. And having some tech support here if you can if you’re dealing with large amounts of data, sensitive personal information, or important data touching on macro-economic/infrastructure/national security issues.?Something I've discussed in prior posts.

To summarize why companies avoid hiring people right away:

(a)?Time to locate, onboard, and train up talent that will understand your unique solution.?All done remotely.

(b)?Making sure you have the right security measures on access to your source code, etc and other IP protection before bringing new people on board especially again, when you can't physically meet them with travel and quarantine challenges.

(c)?Total cost of getting those employees onboard including on social insurance, and potential costs down the road of having to terminate employees (not easy to do compared to say the US) as I wrote about here .

Having said all this, there are still plenty of reasons to hire local talent.?For your customers here its a clear sign of commitment to the market.?There’s also no shortage of benefits to be able to offer local language support and knowledge of the local IT/social media ecosystem you are trying to integrate into with your solution.?

Moreover, being able to keep and use data in China and run your software here is going to be a long-term irreversible trend and an investment worth making as you get bigger to get ahead of that curve, and reduce burden on your customers and improve user experience.

(6)?Settling on a corporate structure.

Structurally, we present many of our clients with options to work with local partners to publish their software using their ICP license or the more complicated VIE structure I’ve written about previously .?But we find and more and more clients leaning towards the interpretation that not all SaaS businesses (including theirs) need an ICP or other VATS license and that a plain vanilla local company (WFOE) is sufficient (at least for the time being).?We generally think this is the right approach for most businesses that can make a plausible (even if not flawless) argument that they don’t need a license and elaborate corporate structure.

(7) Go-No/Go.

Usually companies that have gotten this far along in the analysis hit the "Go" button. But we can see macro-economic conditions (and of course, internal politics) delay those decisions as well.

That's it for a slightly shorter edition of My China Tech Newsletter. Remember to subscribe if you haven't already, and add me on Linkedin. If you follow me, I'll see it and send you a "Connection" request back.

Thanks for reading and see you all back here in 14 days!