Partner structures for China entry with Charlotte Mantoux from LEAF law firm

Welcome everybody to my interview series. This episode of the interview series, we’re talking to Charlotte Mantoux. She is the partner at LEAF law firm who focused really on helping and supporting beauty brands enter the China market.

Welcome Charlotte. Good morning Allie. Thank you very much.

I’m Charlotte Mantoux, in charge of LEAF, Paris office. LEAF Law Firms specialize in merger and acquisition and has developed skills internally or in collaboration with external experts in order to support clients throughout their deals, and in particular cross border operation between Europe and Asia. 

Our experience allows us to fully understand the legal implication and risk of doing business in China to provide efficient solutions, to navigate through complex legal environment in China. Thank you for having me today. 

Yeah, you’re welcome. It’s great to have you and I think we’ve obviously done some preparation before this call and there are a few really interesting topics that we want to get into.

When beauty brands are coming into China, there are several different options in terms of apartments. 

1The first one is distributors. They also trade partners and then we’re now seeing more of certain distributors wanting to take a stake in brands. Let’s start with distributors.

Distributors, one of the downsides of working with a distributor that I often talk to clients about is the loss of control that you have.

When clients are looking at that structure, what do you normally advise in ways of protecting themselves from that loss of control? 

Yeah, with distributors, the brand are pretty safe because they sell the product to the distributor and then the distributor resells it to local customers through their own stores.

This is pretty, uh easy for the brand. However, the protection in this model goes with IP of course. The trademark, cosmetic registration, even wechat ID need to be registered in China by the foreign brand. This is a must to distribute in China on the main Chinese platform and we can still see many brands coming to fairs or exhibition without being protected.

That will be the first main point to be taken before coming to fares or exhibition. Another problem that we see is brands have to deal with. Adapting their decision-making process to the speed of the Chinese market. 

More specifically to the speed of the social networks and e-commerce platforms in China. Distributors are providing the content of the marketing message to e-commerce platforms, and they need to have very fast feedback from the brands sometimes within several hours.

LEAF team invites always its clients to make sure that clear guidelines are established between the brand and the Chinese distributor, so that the messages are clear and in compliance with the brand image. Within that, also brands needs to adapt their message to the Chinese customer. 

If you take a lifestyle brand that communicate with only white models in a certain way of life, like where people are walking in the countryside or doing picnic outside. That message will not speak at all to the Chinese customer and the brand will be damaged.

If the brand only provides this kind of content to its distributors. It’s really that the brands need to adapt its content. Even the name to create touch point with the Chinese customer, and such IP shall also be registered with the Chinese trademark office in China. 

Yes, I think that’s very important where you were saying at the beginning about. Before you come to trade shows, before you start to sort of talk to part potential partners, make sure that you have that trademark and those key IP pieces in place, because otherwise you’re sort of opening yourself up to the potential of someone squatting. 

Exactly. Also we think that the brand image to be preserved, the brand needs to support, the distributor. They need to find a middle way between autonomy of the distributor, and control of the brand. This goes beyond supporting their efforts in marketings or offering training.

That’s a great way to ensure reciprocal collaboration and shared goals between the brand and the distributor. Yes, absolutely. IP, adapt the content, , adapt the message to Chinese customer preserve the brand image, not considering that only the distributor will deal with the sell of the product, but be on the side of the distributor to preserve this brand image.

Yes. Also we recommend definitely to define minimum purchase, to allow the brand to exit in case of non performance of the distributor. Yes. Yes. one thing that you mentioned before about Wechat registration. 

With this brand that is with a distributor, the distributor registers the Wechat or does the brand? Which way would you recommend?

It depends if you do not have a company in China, you cannot register your return ID in China, but you can do it on the Wechat international. Okay, and, what you can always do is, to have the distributor opening it and to insert the clause in the contract stating that, in case the distribution agreement is terminated, They have to transfer if possible, according to the rules of the platform or the social media, to transfer account, to either the brand or any third party designated by the brand. 

Okay. Yeah, I think that’s a good, point the brands maybe don’t think about in the beginning. With distributors, we’re seeing distributors are now changing how they want to work with brands.

Ideally now many distributors want to have, they want to incubate brands. They want to be able to have more of a stake and investment in the brands that they bring into the market. And I know that you’ve done quite a bit of work with brands on this. 

Can you tell us a bit more how incubating brands works?

Yeah. For some cosmetic brands, the Chinese distributor is the largest of their turnover. These distributors are creating the value of the brand and actually they want to benefit from the upside. If the brand is sold to a larger group at a later stage. 

As you can guess, you know the distributor, we lose the distribution of the products and of the brand, if it’s sold to a larger cosmetic group.

When you are in such a case where the distributor wants to incubate the brands, main question is. What is the distributor trying to achieve? Is he trying to only create distribution lock in? That the brand will never be able to be distributed in the market with someone else? Or is it a strategic investment for a potential exit later?

The distributor might want to get some equity early believing that it will be a great upside in case of a trade sale in the brand, in the future. What can you confer to the distributor? What will be his role as an equity partner? You either grant him a seat at the board of the company.

If he becomes an equity partner. The distributor in such cases might bring another vision help to initiate the necessary change to adapt it to the Chinese market. But it may reduce the brand capacity, including in negotiating prices because, the distributor will have access to insider information on the accounts of the company.

And it can allow the distributor to challenge the price increase, but you can also think of limiting access to inform some of the information in the shareholder agreement. When you have your distributor as the equity partner. For example, they will not have access to the patent or formula of the cosmetics products, because you are not the only brand,which is distributed by the new partner. 

You will need to be extremely careful on confidentiality and  non-compete non-competition provision. Depending on the distributor goals, the brand option, if the relation soars or whether the brand is giving any control versus just creating financial opportunities, it could be a good idea or not. We with the LEAF team have proposed some contractual structure.

According to which distributors receive a portion of the capital or of the enterprise value under the form of equity or non-equity mechanism. Of course in that case, we need to define KPIs equivalent of investing that we incentivize the distributor on the longterm to keep on performing.

In terms of the way that the distributors and brands can structure their deals, what is an overview of the popular sort of structures? Okay. There is three types. The Chinese partner can invest directly in the holding company either as equity deal or capital increase.

In such cases often the Chinese market is one of the most important developing markets for the brand, and the distributor is willing to become the equity partner. They want to have a portion of the, equity to make sure that trade sale cannot be done without them knowing it. 

They will try to get, co-sale rights that allows them to sell their shares to the purchaser at the same terms and conditions offered by the majority shareholder of the brand. Of course, the problem will be to value the portion of the equity to be allocated to the distributor. 

Yeah. We can see that some sophisticated distributor will propose a business plan and to invest in the local distribution against the portion of the shares calculated based on financial audits.

We have with a LEAF corporate finance team help to value the brand company and to propose the best financial business model and relevant KPIs to the brand, to allow them to allocate part of the equity to the distributor.

This is the number one. Number two, we can see that companies are incorporating a joint venture, dedicated for the Asian markets.

The Davey model will allow to increase the capacity. Share the risk and the cost with the distributor, and the party will be able to choose the information they disclosed with each other. 

Exactly. We only communicate to each other, sharing the data related to the activity or to the joint project for a dedicated market.

The distributor will not benefit of the full worldwide, benefit of the company, but only on the Asian markets. We can see a third type of structure, which is on non-equity  of bonus may be a fixed price or an amount based on the value of the trade sale, depending on what is decided between the brand and the distributor, but this will allow the founder of the cosmetic brand to keep all the   and not to have the distributor in a lock-in situation. 

Those three structures going from the distributors getting the most sort of, control. Down to the least and I think joint venture is something that’s been being used for quite a while but I think the one that I’ve seen more distributors really keen on is this equity piece that they’re trying, and obviously we can see why. 

With the mergers and acquisition market of especially indie brands globally, with bigger groups buying  from Drunk Elephant, there are so many sort of really high profile examples right?

Yes. What we can see is that often the distributor now goes to start-up cosmetic brands, because if you have the equity at the early stage then it’s easier, and often the brands are not really aware of what will be the consequences at a later stage. That’s what we can see for now.

New brands coming on the market, having good relationships with the distributor,  sharing the equity with the distributor and the distributor will benefit from the upside at the later stage when the company is sold to a larger group. 

And in terms of the benefits for the brands, like of course there is a benefit of having someone who really understands the China market working really as part of your team for a long term if they’ve got that equity or joint venture structure. 

Are there any other particular upsides for the brands that you can see apart from the obvious one, obviously of the Increased interest in the brands success?

Depending on the relationship you have with your distributor  to have them as an equity partner will also lug them in to make sure that they develop the market.

It could be a good option to have them on the side, but you still need to remain careful. There is not only the China market, the Chinese market or the Asian market. That’s why you can rule in the shareholders agreement exactly how the collaboration will be between the shareholders and how the distributor will need to continue to develop the market to make sure that at some time there is this upside.

Absolutely. I think the other thing that I would be interested to know is with these brands that do go down this route, especially with the equity. 

Are they generally brands that you’ve found to have been in the market for awhile and then they do this, or this is really at market entry stage?

Yeah, we can see both actually we can see market entry stage of course. And that’s something that smaller brands, as you sort of mentioned before, really need to watch out for, because you don’t want to get tied in with a partner.

When you’re very early stage and I suppose if you’ve got the right agreement in place and they have to meet certain criteria in terms of developing and continuing to develop your brand, then that’s okay. But a bit like, what say Tmall global does in terms of they get a load of brands onto the platform.

They want as many brands as possible to see which one succeeds. I can see some Chinese distributors having that attitude, because as you said it’s cheaper to get, it doesn’t cost as much to get in early. But then only one of those bets will probably pay off. 

From the brands perspective, they really need to make sure that that distributor is going to keep working for them. 

You’re right and I think also the question for the brand is will you have, the distributor coming as equity partner with an equity deal? The founders are selling equity to the distributor, or do you think that your brands need to have capital increase or fundraising, and the distributor, you will issue new shares of the company.

 Like that the money invested by distributor will go into the company and not into the founder pocket to develop new projects for the brand. In the equity model, These are two options that you have. 

Do you think that you’ve already done a lot of work and you pay off on that having the distributor as equity partner and you sell some of your shares, or do you think that the company needs funding to develop and then you do a capital increase with a fundraising with your distributor becoming an equity partner.

Yes. I mean, most of the indie brands that I’ve seen that have gone down this route, it’s really to get the funds to do the China market in a way that will, that it needs, right. Because it’s an expensive market. 

To be able to really get that splash when you first go in, and you need that injection of cash and you get the added value of having a partner that really understands the market.

There’s that sort of synergy there that I think brands like.

Well then I think the last one is trade partners. Obviously we talked about distributors, but trade partners is another partner option, especially for cross-border brands. 

What do you think trade partners can keep control, much more control of the brand?

It’s much more hands-on. What are some areas that brands should watch out for, with trade partners? 

You say trade partner I say TP so like that  we’re okay. If you want to expand on the Chinese markets and on the store, keep the control, but you do not have time or dedicated teams to manage the resource.

You can consider using the third party providers such as the TP, which we manage to store on your behalf, capture the traffic, work on the conversion into sales. Develop the user interface and the customer experience, and manage the logistical for your brand.

Okay. To expand on the domestic Chinese market. What we can see is, in using the TP model, brand has a stronger control of the brand strategy and the plan for the price channel promotion. All that is decided by the brand, with the help of the TP advising you but usually most TP, are helping the brand to develop this strategy.

Okay. The TP’s are usually on a commission based service. They only take a cut after the product has been sold. Which is making them to work closely with the brand to make sure that, it executes and implements the China strategy, according to the brand requirements. 

What  LEAF team recommend is to have  like a framework master agreement with your TP partner. With various statement of work, and if there is one of the services that you do not agree with the TP or you consider that another service provider can help you to develop this part for the brand.

You can always exit, but keep the main framework master agreement with the TP. You can always add on service provider to it.  We think it’s really a great model for the brands. However, the disadvantage of TP, it’s not really a disadvantage, but the comparison with the business model, is that the brand will have more responsibility and should allocate resources.

For example, for incorporating a subsidiary in China. That’s the first one. You will need to have a subsidiary in China. The brand will have higher marketing and brand strategy cost in China rather than in the distribution model. It’s a higher level of investment on the TP model.

For larger brands this is not an issue, but small and medium sized brands sometimes find this less achievable because of this higher cost. They might go on the distribution model, but with less control. Controlling costs or a distribution model. Yes. The balance for brands that decision-making is difficult.

I mean  with all the brands that I work with we currently do cross border. For cross border, with a TP, you don’t need to have yes, exactly. You don’t need to have a subsidiary. If you want to go into the China domestic market. Then you need to have a subsidiary. If you stay on cross border, for sure no need for, for now. 

But as soon as they start to be on the cross-border, brands are willing to move forward on domestic markets because 2.2% of the sellout on cross border only, but 98.8% other non domestic markets. 

For the brand at some point they will want to develop and if you want to stay with your TP, then you will need to incorporate, a subsidiary in China. Of course. And to have your product registered in China. 

Yes. And that’s all, that’s all for another topic on another day, the changes with animal testing Yes big change. Exactly. And how that will affect the domestic market and many brands that come on from the currently cross border looking at how they’ll move.

I think maybe what we were talking about before in terms of distributors getting equity and especially distributors that have strong links to offline retail. I think that’s something that more brands would be looking to consider, potentially based on these changes.

Totally. The Chinese regulation are moving, changing and it’s standing quickly. 

By the end of the year, they will be new and entry on the domestic markets that the brands were not considering before. Absolutely. 

There’s a lot of things for the brands to consider, but I think we’ve gone through the three main structures and given them some good things to watch out for, because it is tricky. 

Negotiating any of these structures and I think your point with the TP’s about having a master service agreement is a really interesting one and it’s one that brands should definitely look at because often brands that I work with, we will give them the TP will run the operations with the platform as well as the marketing within the platform the e-commerce platform.

But then I would advise the brand to have a marketing agency to really do the brand building piece in China. That’s something that we, we like to look at. 

Depending on your TP. Because some TP’s are very good with marketing agencies. Some are not really, and that’s why it’s always good to exit some part to be able to exit some part of the services, if you’re willing to have someone else coming to assist the brand. 

Yes, exactly. Without making the main contract for, because of that service change. Absolutely.

Charlotte, thank you so much for today. I think there are so many valuable insights there that brands would be able to take away and think about, and when they’re sort of ready to take that first step into the China market.

If they want to get in touch with you, what’s the best way for them to do that? Is LinkedIn a good way if want to reach out or your website? 

We are, we are on LinkedIn. We are on our website, LEAF-legal.com. You can find us both ways we will be happy to assist cosmetics brands for any questions they may have to enter the China market. Fantastic and I’ll put all the details in the notes as well so people can find you easily.

 Thank you so much Charlotte. Thank you very much Allie.

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