Eight Big Mistakes To Avoid In China.

USA (or other country) multinational firm gung ho on China Mergers and Acquisitions takes stake in promising growing firm in restricted investment area (ie. company operating with a business scope restricted or closed to foreign investors). E-Commerce, education, health all come to mind. Company engages global Tier 1 Law Firm to structure the acquisition. Law firm provides complicated advice involving off-shore holding companies in low tax domains, local WOFE, no actual equity stake registered anywhere, and control via licensing agreements, seats on Board or 'trusted nominees', loans & loan agreements. Actual license to conduct the business and all operations & IP sit within a domestic entity controlled by pre-acquisition business owners with no legally registered foreign investment stake within China.

Business grows and is successful. Local former 'owners' realise the potential and 'take over' the business ignoring directions from 'HQ'. Extensive legal advice required from original global Tier 1 law firm by multinational 'owners' on where, when and how legal action might be taken. Local 'owners' move business license, IP, assets and operations to other local entities leaving controlled local entity a shell. Nothing left to pursue for foreign owners....

Tier 1 law firm makes huge amounts from all stages.

The above scenario will play out in many private equity funded 'deals' over the next few years....

Chris,

Uncanny. What you describe matches almost to the letter a case we just took on involving a Tier 1 U.S. law firm that did this work in Japan and cost our client millions. Only difference is that the problem wasn't so much in the restrictions, but the fact that the "loan" my client made was deemed not to be a loan and instead was deemed an investment into what is now a pretty much worthless shell, easily stripped of all assets because the U.S. law firm, among other things, just assumed that the client would have minority rights. But you know the story.....

Yikes! And they own how much of our debt?! And they control what percent of the rare earth market?!! Does anyone else thing "Fiscal Terrorism" might be as scary as any other kind???

Every country is different, but they are different in the same ways, and the problems that issues that you mentioned for businesses doing business in China are similar to the traps that you find in doing business in any new country.

Something that I think you'll find common in all of your stories is that you are dealing with a business that has never done business outside of the US or at least outside of Europe.

Once you've done business in a few places, you start being able to ask standard questions. "What are the restrictions in foreign ownership?" and "How do corporate structures work?" are questions like "Is the water safe to drink?" and "What is the cost of getting a cab from the airport?" and 'Is a visa required?"

Two things that is really important in business is "follow the money" and "know who to trust." If you have a law firm that makes lots of money selling complex corporate structures, then I'd expect them to sell me complex corporate structures. Whether or not they'll sell me bogus complex structures that makes them lots of money and leaves me broke gets in the "know who to trust" part.

Your point #5 is exactly what my last post talks about: the dangers of hiring the wrong company formation firm.... In the case I write about, not only they lost money, it just killed their business (they did not have the resources to start all over again).... And the agent told them it had been their own fault for choosing him!

Start a cool hotel or restaurant in Thailand. After it becomes a hot property, have mafia guys put gun to your head and insist you will sell for 50,000 dollars. Real story.

What Clara mentions happened to me too. The exact same thing but different industries. The company formation company blamed me saying I hadn't been clear on what the business would be doing. I had been clear, but their English apparently wasn't good enough for them to understand. Fortuantely, This company was cut rate in their prices too, but when I went to a real law firm to have this done, they told me they would need to charge me not only to form a WFOE, but to shut down my old one as well. I had no choice but to pay this additional fee so I would finally get things right in China. I have now been up and running for two years and I have learned my lesson.

Too many to mention. No. 5 is not taxable if it is classed as a further capital contribution.

The rules chaqnge as you go along in China, sometimes everyday. Chinese Lawyers are a joke, most are not well educated at all but, even if you hire one of them, they will always find a way to stick it to you and side with the local chinese. They all belong to the same big club (party) and if you are not a member in that party, (foreigners are not welcome) its almost totally impossible to make your project a success. You know the one I'm talking about.
Why do you think they call it RED China? The Sickel and Hammer!
After many years of success in the USA and after eight years of disappointment in China, I married into success. My wife knows how it all works and her family has all the Government connections so, therefore WE are NOW a success.
No honest person would believe how much she pays out in "Kick backs and pay off''s"
to the party just to get the simpelist things done. There are statistics availabe regarding the number of Billionairs in China.

@Clinton. There are tens of thousands of examples of successful, law abiding foreign enterprises in China running great businesses WITHOUT pay offs, kick backs or guanxi. Their success comes from the usual hard work, clear business plan, great people and understanding of the markets they are in... (ie the usual stuff that makes businesses successful anywhere in the world).

It sounds like you and your wife are headed in the general direction of jail, not success.

Dan. The local legal and accountancy firms I work with are excellent, offer great service, strategic options and clear and professional advice. On occasion, our corporate HQ overseas, requires a second opinion from a Global Tier 1 legal or accountancy firm. In 95% of cases, those firms come back with similar advice at ten times the rate. Fine.

The worst legal advice I ever received was when overseas HQ went straight to Tier 1 Global Law Firm with a proposal to enter a restricted investment area. The advice was extortionately expensive, not particularly expert in the area in question, and suggested a messy corporate structure (trusted nominees, domestic companies, licensing to/from local WOFE, offshore holding company etc) that would have ended in grief and loss of investment. Thankfully, we later went to a smaller firm with significant expertise in the area in question that offered an excellent model for legally working with local licensed partners in the business sector in question. We kept control of our area of the business, with some parts delivered by a local partner, IP securely within our WOFE, and overall control.

In this post, Dan was identifying basic legal mistakes, inexperienced foreign enterprises will make. In most of those examples, the mistake is to presume that China operates differently from other jurisdictions and that anything is OK (ie. that unlike the USA, China has no zoning laws, capial requirements, anti-bribery laws, restrictions on dangerous chemicals etc). In other examples, it is not understanding the Chinese company registration framework (capital requirements, taxation etc).

All of the above is basic and sensible due diligence combined with a bit of corporate financial sense. Any foreign business should insist that it directly own and operate it's own businesses in China and be directly in control of the legal entities, trademarks, IP, HR etc within China. All of those issues should be taken very seriously at the company formation stage and due consideration given to genuine capital and cash flow requirements, IP, trademarks, licensing etc very early. Company structure & formation is a serious business and should be a key corporate concern.

The difference between the two systems comes down the cultural values. There will always be the exception to the rule, but in general westerners and Chinese (Asians) have completely different value systems. When two people from the same value system work together. There are "unwritten" standards, rules and expectations. In a western value system, there is a general belief that the contract guides the relationship, no matter the change in circumstances. So there is no outrage when one party does not follow the letter of the contract. Everyone from that value system know who is right and who is wrong (ethically, at least and most likely legally).

But when two parties from seperate value systems interact, both sides can be taken aback by the actions of the other as those actions might not meet the values of thier system or culture.

The term "a gentleman's agrement" has certain value in some western cultures. However, a gentlemens agreement to a Chinese person may not hold the same value.

The story of the foriegn tenent of a luxury apartment who asked his landlord to replace an expensive office chair that broke was outrange when the landlord replaced it with a $2 steel folding chair. For westerners, there is a certain unwritten or spoken expectation that the landlord would have replaced the chair with one of equal "value", "style" or "quality". But for Chinese, especially when a foriegner is involved, the expectations are different.

You just have to accept that it is different. It will outrage you. It will piss you off to no end. But if you want to do business here you either have to adapt or leave.