Financing a Small or Start-up Business in China

June 14, 2012 Posted by China Briefing Reading Time: 8 minutes

Op-Ed Commentary: Chris Devonshire-Ellis

Chris Devonshire-Ellis began Dezan Shira & Associates before China’s legal services industry was codified, and when business and foreign investment laws were rudimentary. The practice is now a multinational business with 17 Asian and 2 liaison offices spread across 6 countries. This episode deals with financing a small or start-up business in China.

Jun. 14 – One of the main problems young, entrepreneurial start-up businesses face is a lack of capital. In the very early days of Dezan Shira & Associates, I had to support the firm by taking another job – and for a year I was the English-speaking face of Shenzhen TV’s “Five Minute English,” a short program that required daily filming immediately after work at 6 p.m. at the studios of Shenzhen TV, and then subsequently broadcast locally 10 times a day. I became quite famous, and was also able to earn additional money on the weekends by being a relatively well-paid English teacher to the newly-wealthy Chinese who wanted to send their children abroad to study. The lesson here is to stick with your dream and, if necessary, find other ways to subsidize it. I wanted the firm to succeed so much I taught English on the side to keep me going. Entrepreneurs need to do what they can to keep their business afloat.

Eventually, the stress of running two jobs was getting too much and I ditched the English teaching when the firm was turning over just enough to support its running costs and my daily expenses. But I still wasn’t earning a salary. I had a strict budget, and I recall allowing myself HK$100 a day – and that had to cover food and travel. I was effectively living at the time on a budget of US$370 per month. But again, I could afford to do so – a large bottle of beer was RMB3, and I could buy a plate of hot noodles for RMB1 in certain parts of the city. Although it wasn’t glamorous (and at times like that you can forget about having girlfriends for a while), I kept plugging away and putting whatever money I was making from Dezan Shira & Associates’ work setting up ROs and registering trademarks for clients to the side – there was absolutely no chance of getting a bank overdraft in China to fund the expenses.

Little by little, that hunger translates into business, and on a budget such that I was living on, a trademark registration fee for US$2,000 was a lot of money. Cash is always relative, and I could live on that income for several months if I was careful.

The term for not letting banks into your business has a name – bulkhead financing – and keeping the banks out of the firm became a mantra. Firstly, it was down to the fact they wouldn’t lend me money anyway, then later it was a matter of desire to get over the hump and fund cashflow standing on our own two feet.

That’s tough since cashflow remains king in any business, and financing expansion – an office here, another staff member there – requires ongoing and sustainable capital. The business model of course has to feed that, and Dezan Shira & Associates was involved in accounting and tax filings as a source of much-needed sustainable monthly revenues. Businesses that constantly need to sell, especially services on a one-off basis, run cash flow risks all the time. That bulkhead financing technique, although tough at first, is still employed internationally by Dezan Shira & Associates today. The practice carries zero debt, has no borrowings and no bank overdrafts anywhere. That makes the operational and financial management of the firm far easier since the money is in the bank, it belongs to us, and there are no external influences acting upon how we utilize our funds. I cannot imagine a sleeping partner (or a bank) involved in our business and then making demands based upon their needs and not that of the business. Bulkhead financing should be taught in MBA programs. The fact it is not plays right into the systematic hands of creditors and bankers, who are then in a position to take a permanent cut of your cash-flow.

Another aspect to be very aware of is your target client. It sounds simple, but you must target clients who will pay, and preferably take on those who will do so on time as well as possess the ability to order other services. Dezan Shira & Associates specializes in handling foreign investors into China. We only deal with foreign clients and we specifically do not handle Chinese clients. With 12 offices across China we are of course very well positioned to do so if we so wished, but we don’t, and the simple and brutal reason is that Chinese clients, for us at least, represent far more of a financial risk than we are willing to take on.

We have pushed the buttons on numerous occasions over the years and the harsh reality is that Chinese clients do not fit our credit cycle. They are not prepared to commit to a large enough sum to cover the risk of their reneging on full payment. On nearly every occasion we have tried, we ended up with both a receivables problem and had to write off bad debt. The Chinese are well aware that litigation in China is both time consuming and costly, and there is a commercial tendency for them to renege on the payment of a deal that is just not worth the time and effort to follow up on. That does not fit into our idea of a good consultant-client relationship, nor does it match our credit control standards. In order to take on a Chinese client base, you must have deep pockets ready to service an extended receivables or bad debt problem, or get out of the business of dealing with them directly and passing that responsibility elsewhere.

Of course it is possible to do business and get paid by clients in China, but in the services industry, the risks are too great for us to take on. Accordingly, we skip those and let our competitors deal with them and the resulting hassles. I have receivables averaging 60 days and close to zero bad debt, I wish to keep it that way, and going out to attract local business in China would be a drain. For SMEs, that is a serious problem, and I’d think twice before targeting an exclusively Chinese customer base unless you can work out some built-in protection.

Essentially, running a small or start-up business, especially from the financing perspective, requires modesty, commitment to hard work, and a specific business model with achievable goals. I have seen plenty of professional services firms fail in China, many at some considerable expense. Clients “driving” firms to China and partners approving an office, then spending hundreds of thousands of dollars to fit an office out, plus salaries and other operating costs (I’ve seen the investment bill run into a few million dollars by the time the office has opened) only for a lack of attention to detail over cash-flow planning and far too optimistic revenue projections to result in such offices lasting less than a year before closing. I’ve seen small entrepreneurs rush out when they’ve just begun their business to go and buy a Mercedes because “it’s the right image.” Such matters are a triumph of ego over reality.

Today, when I sit down with my staff in my many different offices, stretching from Beijing to Delhi and from Singapore to North Carolina, I always ask to see the revenue projections. I then ask specific questions about each projected income stream, and if I’m not satisfied with the story, I cut it out of the projections. My staff look at me aghast. Sometimes I have cut out 50 percent of the total amount. I’ve also always found that in being severe over revenue projections I am more often right than wrong while sales people always want to look on the brighter side. I have to run a business, however, and I fix our cash flow projections and associated expenses with my more realistic view of the revenue streams, and not that of someone telling me “we’ll get this client.” If I don’t understand, or have doubts about why that particular client project will come in when stated, I cut it out or move it back in the cash flow projections. I’d rather have a pleasant surprise in my cash flow than a nasty shock – especially now when the business turns over millions of dollars.

It’s never a deal until the money is in the bank, and even today, I don’t have a Mercedes. In fact, I don’t have a car at all. If I did, all my offices would try to justify having one – and nowadays that would be a lot of vehicles!

Chris’ start-up tips

Try not to borrow money, and resist bank overdrafts. They make your business dependent upon someone else.
Don’t let ego overcome reality. You can’t afford a Mercedes when you have no clients.
Get into the habit of paying your bills on time and within 30 days. Ultimately, it means you get ahead of yourself in your cash-flow planning.
Research your potential clients and their ability to pay before doing business with them.
If you can’t be 100 percent sure a business deal is coming in, exclude it from your cash flow projections. That gives you the real picture – and a nice surprise if it does drop in.
Try and build up reserves. You never know when something will go wrong – and I can assure you something will. You shouldn’t blow what you may later need.
It’s okay to celebrate your losses. You’re not going to win every deal. I used to have a little celebration when we lost a deal – as long as I’d learned something from it.
A raw truth: It is never a deal until the money is in the bank.

Dezan Shira & Associates includes SMEs as part of their client base in China and are happy to provide experienced practical assistance and advice. The firm has also assisted with the China licensing and ongoing accounting for several foreign law firms in China.

Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates, and established the firm in 1992. Since then, Dezan Shira & Associates has grown into one of Asia’s most versatile full-service consultancies with offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States. Chris regularly contributes to China Briefing as well as our associated titles India Briefing and 2point6billion.com. The firm celebrates its 20th anniversary in November this year and will be hosting a series of commemorative events for clients and friends of the firm across China.

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