European antitrust developments
As predicted in the previous CMT Updater, 2010 looks like being a difficult year for Google. Following the opening of investigations by a number of antitrust authorities in the EU, the European Commission has now confirmed that it is also examining complaints that Google has abused a dominant position in the online search engine and online advertising markets. Two of the complainants - Foundem, a British price comparison site, and ejustice.fr, a French legal search engine - have apparently both complained that Google has deliberately relegated their websites - which might be seen as competing with services offered by Google - to an unfairly low ranking in Google's search results. The third complainant - Ciao!, a German online shopping portal owned by Microsoft - allegedly complained about the way Google sells adverts. Although no formal investigation has been opened by the Commission yet, it has confirmed that it has asked Google to comment on the complaints.
In contrast to Google's position, things are looking a lot brighter for Microsoft. It is acting as complainant rather than defendant in the Google investigation, it has obtained a non-conditional clearance from the European Commission for its tie-up with Yahoo, and has also received approval from the European Commission for the way it has implemented the commitments made in December 2009 to allay concerns that the company was abusing its dominant position in the market for client PC operating systems through the tying of Internet Explorer to Windows. Windows will now offer consumers a choice of web browsers and Microsoft has also committed not to retaliate against PC manufacturers who pre-install a non-Microsoft web browser on the PCs they ship and make it the default web browser. Microsoft will now report regularly to the European Commission on the implementation of these commitments, which are likely to be reviewed in two years' time.
For further information on these antitrust developments, please contact Mark Tricker in Brussels.
Recent trends on public procurement and "indigenous innovation" in China
As part of China's government push to develop the creation, development and commercialisation of technology and intellectual property by Chinese companies (the so-called indigenous innovation strategy), the number of preferential policies, product catalogues and specific financing schemes used by Chinese government agencies has increased in recent years.
Against the background of a massive US$586 billion package made available by the Chinese government to stimulate the Chinese economy, a heated debate is taking place in China between foreign companies and the Chinese government. Some foreign companies have accused the Chinese government of implementing policies that restrict their access to China's government procurement marketű and Chinese top officials have replied by promising "national treatment for foreign firms according to Chinese laws".
In this context we note the following latest developments:
- Accreditation Program November 2009
On November 15, 2009, the Chinese Ministry of Science and Technology (MOST), the National Development and Reform Commission (NDRC), and Ministry of Finance (MOF) issued a joint release detailing the 2009 National Indigenous Innovation Products Accreditation Program (Notice 618).
Notice 618 announced the creation of a new national-level catalogue of products eligible for procurement by the Chinese Government and clearly stated that companies wanting to take part in public procurement would be required to gain accreditation for their products before they could be included in the government procurement catalogue. Companies excluded from the catalogue are still permitted to bid on contracts with the Chinese Government, but preference is likely to be given to companies listed in the catalogue.
Notice 618 focuses on six high and new technology fields: "1) computers and application equipment; 2) communications products (e.g. mobile phones); 3) modern office equipment (e.g. scanners); 4) software; 5) new energy and new energy devices; and 6) high-efficiency and energy-saving products".
To qualify for the catalogue, companies and their products must satisfy a set of conditions, some existing since 2006 and some new. Two conditions are a subject of concern for non-Chinese companies:
- the intellectual property attached to a product must be free from foreign restrictions on its use, disposal or improvement; and
- trade marks associated with a product must be owned by a Chinese company registered in China.
- Catalogue of industrial equipment products - December 2009
On 29 December 2009, MOST, MOF, Ministry of Industry and Information Technology and the State Asset Supervision and Administration Commission jointly released a catalogue of industrial equipment products specifying which products they require domestic companies to develop in the manufacturing industry. The equipment is listed in the catalogue as "national indigenous innovation products" and will be incorporated into the yet-to-be-released national-level Catalogue for Government Procurement of Indigenous Innovation Products. Foreign invested enterprises (FIEs) currently import or develop many of the types of equipment listed in this catalogue.
- Draft implementing regulations for PRC Government Procurement Law
On 11 January 11 2010, the State Council's Legislative Affairs Office released for comments draft Implementing Regulations on the Government Procurement Law (the Draft Implementing Rules). Interestingly the draft made public defines domestic products, projects, and services in a way that appears to include FIEs. Specifically, Article 10 of the Draft Implementing Rules defines a "domestic product" as one "made within China's borders and for which domestic manufacturing costs exceed a certain percentage of the final price." Such a definition is widely interpreted as allowing FIE products to pass a local content threshold and to qualify as domestic for the purpose of government procurement. The Draft Implementing Rules are silent on the percentage of domestic content required to qualify a product as domestic.
Indigenous innovation is repeated throughout the draft regulations, reinforcing the notion that it is an increasingly important concept in the minds of PRC policymakers.
FIEs seem to be likely to qualify as domestic companies for government procurement purposes. However, if FIEs want to enjoy the protection given by indigenous innovation qualification, they will have to make a special effort as to the localisation of the ownership of their trade marks and of the development and use of their IP. FIEs will probably have to rethink their IP strategy for China and assess how far they are willing to go in localising IP in China to win government procurement bids.
The consequences attached to the current trends in government procurement in China remain to be fully assessed and may actually backfire against Chinese local companies. For example, Chinese software development companies using free software such as Mozilla or Linux to develop their own products may not pass the indigenous innovation test.
More broadly, this raises the question of how FIEs and foreign companies want to remain competitive in the Chinese market and differentiate themselves from their local competitors.
Finally, any dispute between the Chinese government and foreign enterprises has to be put into the context of the current negotiations for accession to the Government Procurement Agreement by the Chinese government. It remains to be seen whether the latest developments in public procurement in China will be compatible with the future GPA to be entered into by China.
For further information on public procurement in China, please contact Gergory Louvel in Beijing.
The PRC government procurement law is wide enough to apply to all purchases made by government agencies at central, provincial and local level.
Challenging times to raise growth capital
These are difficult times for technology companies to raise growth capital. IPO windows have been largely shut worldwide and while there are some hints of renewed IPO activity soon this option will only ever be suitable for a few. Private capital is also scarce. Fundraising for venture capital and later stage private equity has ground to a virtual standstill, while those established funds sitting on capital raised in better times are cautious. There is some investment activity by large technology companies (often seeking majority control, but not always) which tends to favour complementary technologies or competing technologies as part of a defensive strategy.
Against this background negotiating power on any particular deal tends to be slanted in favour of the investor, who is spoilt for choice and rarely needs to compete for the deal. Instead it is the technology companies seeking growth capital who are competing for scarce risk capital.
Technology companies who are successful in attracting investor interest should be prepared for not only a tough valuation but also other investment terms which reduce the investor's risk and increase the investor's upside (often at the expense of existing shareholders). Examples of such terms include:
- A deal structure where the investment is tranched against milestones being achieved and where the tap can be turned off if a milestone is not achieved;
- The initial investment being structured as a convertible loan, at least until key milestones are achieved;
- Preferential equity terms where the investor receives its capital back (or even a multiple of that capital) in priority to other shareholders on exit and a preferential dividend in the meantime;
- Anti-dilution provisions which seek to protect the investor against dilution in any subsequent 'down-round', but at the expense of other shareholders for whom the dilutive effect of the down-round is magnified;
- Options to invest future capital at pre-agreed valuations or first rights to invest or arrange future capital;
- Key person provisions which link share incentives and share retention to continued employment and performance and which provide for different treatment when a key person leaves, depending on whether they are a 'good leaver' or 'bad leaver';
- Drag rights and rights to force a sale after a specified timeframe which enhance the investor's ability to force an exit;
- The investment being tied to an agreed business plan which can only be deviated from with the investor's approval;
- An extensive list of 'reserved matters' which effectively ensure that most significant decisions must be approved by the investor;
- A board structure which ensures that the balance of power at board level is held by independent directors who are acceptable to the investor.
The latter provisions protect the investor where the investor acquires a minority shareholding, largely negating the effective control of the majority in all important respects.
From the perspective of the technology company raising capital and its existing shareholders, acceptance of terms such as those outlined above may be the price of obtaining the capital needed to grow. However when considering the acceptability of such terms they should have particular regard to whether the investor's interests are aligned (and likely to remain aligned) to those of the company and other shareholders and whether the investor will contribute positively to the company's development (beyond just providing capital). Often these considerations are more important than the deal terms themselves.
The investment terms discussed here are dealt with in more detail (albeit from an investor perspective) in an article recently released to our Middle East based clients.
For further information on investment in the Middle East technology sector, please contact Andrew Lewis in Dubai.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.