A new session of the China CFO Salon is held in Beijing recently. Henry Sha, CFO of Zhihu Inc, shared his insights with the participants during the session. (PROVIDED TO CHINA DAILY)

Can a chief financial officer become a gatekeeper of corporate strategic investment? If so, how can they do it effectively? Henry Sha, CFO of Zhihu Inc, China's largest knowledge-sharing platform company, addressed the participants of a recent China CFO Salon in detail in Beijing.

As a CFO of an internet company playing the role of a "gatekeeper," it entails maintaining a cautious attitude and coordinating team efforts throughout various stages of strategic investments in order to maximize values for the company while controlling investment risks.

The role's responsibilities encompass different stages of strategic investments, including the preparation, execution, operation, and post-investment phases.

Preparation: Clarifying actual needs and defining responsibilities

The starting point for making an external investment is to identify and clarify the objectives of the investment. A company's external investments are primarily driven by strategic objectives, while a few of them are made for financial considerations.

To achieve a company's investment objectives, the groundwork should be laid in twofold: building a professional investment team and establishing an external investment procedure.

First, from the perspective of team establishment, Sha suggested that if conditions allowed, a company's investment team should be separated from the finance and legal teams while still being able to collaborate with the strategy-making team.

Second, it is crucial to build up a clearly defined external investment workflow, particularly on decision-making mechanisms and departmental responsibilities in advance.

Henry Sha, CFO of Zhihu Inc, shareS his insights with the participants during the session. (PROVIDED TO CHINA DAILY)

Sha emphasized that the CFO should pay close attention to situations where responsibilities become unclear in practice. To tackle these situations, he suggested setting up an investment committee and clarifying the project decision-related mechanism within the committee.

Execution: Ensuring processes and balancing risks

During this phase, the CFO should act as a "gatekeeper" by overseeing the risk assessment of the entire project and tempering excessive investment enthusiasm. Throughout this process, some related questions may arise, such as whether due diligence should be conducted internally or by third parties. These questions often demand further considerations under specific scenarios.

Furthermore, achieving a balance between overall investment returns and risks is crucial. As discrepancies often emerge between the accounting perspective and business value returns, coupled with the non-quantifiability of strategic value itself, making the balancing of returns and risks an important consideration in the company's strategic investment process.

Operation: Thoughtfulness and prudent attitude

The CFO also has practical considerations, which can be broadly categorized into two points.

Firstly, there is the issue of establishing the structure of the external investment entity in many VIE companies. For domestic structure entities, there are two options: limited liability companies and limited partnerships.

Sha advised CFOs to exercise their influence in the decision-making process of choosing the investment entity with more comprehensive thinking. Additionally, establishing industrial funds through partnerships with other companies or limited partnerships was also a good choice. This option bears two benefits: on the one hand, it allows a company to utilize more external capital. On the other hand, it enables the company to isolate potential risks associated with an external investment from the core operations of the company. For a public company, these two benefits bear critical importance.

In terms of negotiating external investment terms, Sha had a habit of personally studying the clauses and focusing on specific issues. Although negotiations typically generate a general framework, a CFO has autonomy or influence in specific financial terms. The CFO shall pay attention to all major legal documents, particularly critical investment terms and clauses, with a cautious attitude.

Post-investment: Establishing systems and exit strategy

Professional teams are of great assistance in the establishment of a post-investment system. There are numerous operational tasks to be handled in the post-investment phase, such as annual audits and board meetings. In most cases, establishing a reliable internal control team and corporate tax team can help alleviate the workload.

Henry Sha (right), CFO of Zhihu Inc, shareS his insights with the participants during the session. (PROVIDED TO CHINA DAILY)

Sha emphasized that tax considerations might become a vital consideration in exiting an external investment. To give an example, when exiting an investment project, it should be noted that transferring overseas equity of Chinese domestic enterprises is considered an indirect transfer of assets within China. This will lead to tax obligations in China. In terms of determining and preserving the tax basis of investments, for example, when investing in offshore equity of a Variable Interest Entity (VIE) structure, if the invested company fails to timely repatriate the foreign investment funds in US dollars back to China (capital increase transaction), it is likely that the domestic tax authorities will consider this investment to have minimal cost, leading to a relatively high estimation of the investment return from the tax authority's perspective.

After the presentation, Sha answered the questions raised by the audience for further discussion and elaboration.

Question 1: At what stage does a company need to establish a dedicated investment team?

For companies with annual revenues exceeding 1 billion and a workforce of 700-800 employees, it may be advisable to have an investment team consisting of at least three members. Sha believes that companies should focus on solidifying their core business before engaging in external investments. When facing a highly uncertain external environment, business profitability should be prioritized. Sometimes, if the investment project lacks strong alignment with the company's strategic goals or the investment return is too remote to be clarified, it might be recommended that the company can make the investment through newly established industrial funds through separate entities or a limited partner rather than executing the investment under the company's name.

Question 2: In terms of the relationship between the CFO and an investment team, there are two possible structures: one is where the CFO manages an investment team, and another is where a separate deputy general manager oversees an investment team in a parallel relationship. Which structure is more effective for risk control?

In practical operation, it is more advantageous for risk control when the CFO manages both the strategic investment team and the risk management team (including finance and legal). However, this organizational structure requires significant time and effort from the CFO and comes with a high level of responsibility. Additionally, if a CEO has a strong understanding of corporate management, both structures can work well, and there is no absolute answer. From a risk control perspective, it is preferable for the CFO to manage the investment team, but this approach may also bring about challenges, such as efficiency concerns.

Question 3: How do you address the challenge of quantifying returns in the strategic investment process? How do you measure the strategic significance and valuation of projects?

The prospects of strategic investments are not always easy to assess directly. CEOs and top-level executives often have a clearer understanding of the strategic aspects of an investment. It is challenging for the investment team to accurately calculate future returns based on Return on Invested Capital (ROIC) and Return on Investment (ROI) as these two indicators heavily rely on market prices. Ultimately, the CEO may rely on the CFO to evaluate investment returns. In the internet industry, there is a significant need for exploratory and strategic initiatives. If a project has the potential to expand into a new market or increase the company's market share, negative ROI may still be acceptable in the short term.