China is notorious for its bureaucracy and the business registration process is no exception to the country’s penchant for regulation. Unlike many other countries, registering a business in China may require the assistance of an agency authorized by the government to assist with the process. Prior to October 2004, companies were not allowed to register themselves but were required by law to use an authorized agent. With China’s constantly changing regulations, inconsistencies with interpretation and enforcement, and general lack of transparency, the process of properly establishing an entity to ensure against encountering problems in the future is far more complicated than in more developed markets. Engaging the services of a qualified consultant can substantially improve chances of avoiding problems with compliance and decrease the time to get established.
1.Nature of the Investment
When a foreign investor decides to launch a business venture in China they will need to decide either to launch their business in the form of an actual capital investment, or to start out more cautiously by scanning the market, building networks, and/or using local representatives.
Foreign investors without a comprehensive understanding of the China market may wish to test the market first to see if it is worth it to establish a legal entity in China and invest a large sum of capital.
Foreign investors with more experience and understanding of the China market, who intend to conduct a full range of business activities, should consider establishing a legal entity. In the case that a legal entity is preferred, the form of the entity chosen is crucial. Aspects that have to be considered are the sector of business and amount of money invested, as well as if a Chinese partner is desirable or even mandatory for the business, along with other general commercial and strategic considerations. In addition to the level of financial risk and control a company prefers for its China operations, government restrictions on specific industries affect the investment type made. Media, automotive, and telecom industries are examples of industries that may require foreign invested enterprises to have local partners.
A Representative Office (Rep. Office) represents the interests of the foreign investor by acting as a liaison office for the parent company. Rep. Offices may conduct market research, develop partnerships and business channels; however, all business transactions, including issuance of invoices, are managed by the parent company. Furthermore, Rep. Offices may not directly hire local employees but must rely on a government-authorized employment agency, but may hire a maximum of four foreign employees. Since Rep. Offices do not have a minimum investment requirement, they are not considered a Foreign Invested Enterprise. Rep. Offices are the least complicated way for a foreign firm to have a legal presence in China and were, at one time, the first choice for foreign companies with little or no previous experience in the country. However, given the restrictions on direct employment of local employees, transactions, and taxation on expenses, Wholly Foreign Owned Enterprises are typically a better option for entrants seeking to develop their business in the China market.
Wholly Foreign Owned Enterprise (WFOE), the most popular Foreign Invested Enterprise (FIE), is a limited liability company fully invested by one or more foreign investors. Along with the rights afforded to a Rep. Office, a WFOE may also legally conduct business transactions within China and hire local employees on its own accord. However, they do have a minimum investment requirement that is dependent upon the locality and nature of the business. WFOEs are becoming more and more common and have begun to outpace Joint Ventures as the most popular vehicle for a China presence.
Equity Joint Venture (EJV) companies have capital investments from both local and foreign firms. The percentage of the capital investment determines the amount of profit and risk that both the foreign and local company assumes. Foreign firms entering industries where WFOEs cannot operate often use JVs, although this is becoming less prevalent as more and more industries begin to gradually open up to WFOEs.
Cooperative Joint Ventures (CJV) are also partnerships with a local company; however, the amount of risk and profit shared by each party is not determined by capital investment, but rather agreed upon at the beginning of the partnership. CJVs were used more in the 1990s when the Chinese economy was not as developed. International companies often injected funds while the local Chinese companies provided equipment and other necessities. Laws, regulations, and procedures for establishment can vary substantially between industries.
The common risks associated with entering into partnerships with other companies applies in China and is often exacerbated by disparities in culture and business practices between the foreign and local partners. Foreign Companies should enter into JVs only when both parties have reached a clear understanding of the business objectives and appropriate exit strategies have been developed.
Mergers & Acquisitions (M&A) as a means to invest in China has become an increasingly popular trend in recent years. There are many options for M&A in China, including equity and asset acquisitions as well as mergers. As a form of foreign direct investment, the general rules on establishment of FIEs also apply to M&A.
Below is the typical process for setting up both FIEs and Rep. Offices. The government offices involved in this process include the Ministry of Commerce, the Administrative Bureau for Industry and Commerce, State Administration of Foreign Currency, Tax Bureau, the Customs Office, and the Statistics Bureau.
FIEs - WFOEs and JVs - require the foreign investor to establish a minimum amount of funds from abroad within China, called registered capital. The amount of registered capital must be declared during the licensing phase of the registration process. The total investment figure is represented by a ratio between foreign contributed capital and debt. The registered capital should cover all the initial investment expenses that the foreign entity will have and may be used immediately for the newly formed company’s expenses. This may include paying rents, salaries, purchasing products, etc. It is considered a felony to state a specific amount of funds and then not contribute that amount. It is also a felony to inject the funds as stated and then withdraw the injection. One purpose of the registered capital is to provide confirmation to creditors of the company’s financial adequacy.
According to China company law, most SMEs entering the market are required to invest a minimum of US $4,800 (RMB 30,000) for a multiple investor WFOE or US $16,000 (RMB 100,000) for a single investor. In practice however, this kind of a capital injection would rarely cover the start up expenses of any company. Furthermore, in order to receive government approval, the required amount is usually substantially more. In general, it can be stated that the investment required is dependent upon business scope, volume of sales, company size, location of setup, and judged on a case by case basis. Chinese authorities will consider what would be a reasonable capital injection for each specific project in question.
4.Nature of the Business
For Foreign Invested Enterprises - WFOEs and JVs - the nature of the business must be declared during the licensing phase of the registration process. The intended scope of operations in China and the capital investment the company is willing to make determines the category of business that a foreign company declares. The following categories are by far not exhaustive but represent the most common forms of foreign invested enterprises operating in China today. Other categories of business include Purchasing Centers, Research and Development Centers, Investment (Holding) Companies, and Regional Headquarters.
As the name implies, the foreign firm provides services to either companies or consumers. In most cases, the company may not manufacture or trade goods. Examples of service companies include consulting, training, restaurants, and management service providers.
The nature of this business allows the foreign company to produce goods for sale on premises as well as sell finished goods domestically and internationally. Manufacturing companies do not require an intermediary to sell goods locally or internationally and may import raw materials for production. The registration process, however, might be more complicated than other business categories as manufacturing plants may require additional certifications.
Foreign-Invested Commercial Enterprise (FICE)
A FICE allows foreign companies greater flexibility in terms of business activities. These activities include retail, wholesale, and franchising operations. Once established, a FICE is granted both import and export rights. FICEs may also buy and sell products freely in China without an intermediary. It is also possible for manufacturing FIEs to apply to extend their business scope to include FICE capabilities and vice versa.
As foreign companies entering the market begin to navigate the bureaucratic landscape, having a clear understanding of the investment and business options available will be crucial to successfully establishing a business and operating in China. With China’s gradual compliance with its WTO membership obligations, the business registration process should continue to improve while more industries are open to foreign investment.
When choosing a business registration agency, foreign companies should consider the agency’s knowledge of recent policy changes, transparency on the registration process, and its track record of successful registrations. Selecting an appropriate service provider that can effectively guide foreign investors through the complicated process will go a long way in ensuring a smooth market entry.