In a previous blog, “Could China Successfully Snatch up Assets in the United States?” I predicted that China may take advantage of the global financial crisis to acquire valuable but deeply discounted assets globally.  Indeed, China recently has been involved in several overseas natural resources acquisitions.

Now, China seems to be ready to shop overseas for best small- and medium-sized enterprises (SMEs), especially the high-tech ones.  This move probably makes more sense.

SMEs are the most dynamic element of any economy, driving innovation.  The rise of the Silicon Valley in California, for example, is attributable to the vitality of rapidly developing and innovative SMEs.

However, SMEs, in their early development stage, are usually thirsty of funds and have limited recourse to raise money.  Normally as many as 80 percent of all SMEs starting up die off within the first two years; under the current economic difficulty, credit-starved SMEs may run out of cash before they even work out a viable business model.

In the meantime, while venture capital to SMEs is like blood to the heart of the human body, the crisis also drains the money invested into such funds, so that some venture capitalists may have to exit prematurely, as they may not survive the crisis and thus see the initial public offerings of their invested ventures.

All this may provide China with the opportunity to buy or invest in overseas SMEs, to obtain their assets, especially technology and know-how.  Doing so will provide investment alternatives for China’s enormous foreign currency reserve and help restructure the Chinese economy. Therefore, several Chinese provinces have seriously considered dispatching scoping missions abroad.

The Chinese acquisition of foreign SMEs is less likely to be closely scrutinized by foreign governments or regulatory bodies.  That is, in approaching them, Chinese companies will face fewer obstacles as those encountered by the China National Offshore Oil Corporation (CNOOC) in its failed bid for Unocal, or by China’s PC maker Lenovo even it successfully acquired the PC division from IBM.

Of course, the move by Chinese companies is not risk-free.  One major question is how the assets of these SMEs, especially their intellectual property rights, are priced.  As most of the Chinese companies do not have experience in this regard, they will have to depend upon foreign professional services to do the due diligence, which will be costly.

Second, as the most precious asset of a company is its talent, whether Chinese companies are able to retain the technical experts of the acquired SMEs ultimately determines the chance of success of the acquisition.

Third, other typical challenges include: managing overseas entities, integrating different cultures, and dealing with unions and labor relations in a different environment.  Local Chinese companies, who do not face these issues in their Chinese operations, will have a steep learning curve ahead of them.

Despite the fact that the likelihood for failure of such acquisitions is not small, it does not mean that acquisition of SMEs from overseas is not worth pursuing; instead, it is more likely to be better investment than China’s investment in U.S. treasuries.