Archives: China WFOE formation

I am going to be speaking at USC this weekend and in poring over old PowerPoints (to create a new PowerPoint for my talk), I came across one with a fairly extensive China law bibliography of some of our most helpful posts.  This bibliography is definitely slanted towards the legal issues that confront foreign companies doing business in China.

Here it is:

CHINA CONTRACTS

CHINA LICENSING AGREEMENTS/CHINA DISTRIBUTOR AGREEMENTS/CUSTOMS

CHINA COMPANY FORMATION/CHINA WFOE FORMATION/CHINA JOINT VENTURES

NEGOTIATING WITH CHINA

CHINA —INTELLECTUAL PROPERTY

More from the Doing Business in China Seminar I co-moderated last week.

My law firm does a considerable business in forming China WFOEs.  Unlike forming a company in the United States, which costs very little in out of pocket costs (always less than USD$1000) and takes almost no time at all (a few days at most), forming a company in China can be a long and expensive process. We typically start the procedure by sending out an email with the following LONG list of questions and document requests

  • Legal Name and Structure. Full legal name, legal structure (corporation, LLC, partnership), state of formation, and registered legal address of the shareholder of the WFOE. I assume that your U.S. entity will be the shareholder. If this is not correct, please explain.
  • Company Registration Document. Most recent registration document (usually called an annual report) from the state of formation showing the name, address and officers and directors of the shareholder. Our office can obtain this document after we receive your response to item 1 above.
  • Proof of Shareholder Existence. For this we will need certified copies of a) a certificate of good standing and b) the most recent annual report for the shareholder. These documents must be authenticated by the secretary of state of the state of formation and also must be authenticated by the applicable Chinese consulate or embassy. This is a complex process. Our office will handle obtaining these documents and processing with the relevant Chinese consulate/embassy.
  • Name of WFOE in Chinese and English. We can assist in selecting the name if you wish. Chinese company names are complex. For now, what we need is the basic name that you want. We will then work with the local authorities to determine what should be the full legal name. Note that China is really only concerned with the Chinese version of the name. There is no real control on the English name that you use.
  • Lease of Space for the WFOE. The lease must be valid for at least one year beyond the eventual approval date for the WFOE. Since approval may take some time, it is best to have the initial term of the lease be at least one-and-a-half to two years. The lease must be in proper format and must be registered with the local real estate authority. We will also need proof that the landlord owns the property in question and has the authority to enter into the lease. This is usually proved by provision of a land rights certificate and proof of existence of the landlord (National ID for an individual, business license for a company). We will work with you during the leasing phase to ensure the lease is properly executed and that the landlord has proper authority. Prior to your entering into the lease, we will determine whether the proposed use is permitted for the premises and whether the proposed address is acceptable for a WFOE. Leases are often the biggest obstacle for WFOEs, so this is a matter to address right away. Note also that the specific details of the documentation requirements for a WFOE depend on the district where the WFOE will be formed. We therefore need to know the proposed address for the WFOE or at least the proposed district before we can make a final determination of the exact procedures that will be required for WFOE formation. Note also that we cannot even begin the registration process in China until we know the address of the proposed registered office for the WFOE, as well as the proposed use. This highlights the importance of the lease in the registration process.
  • Scope of Business.We must specify the scope of business of the WFOE. Please provide a statement of what services the WFOE will perform on a daily basis. We need reasonable detail for this, but no more than one page. The scope of business should address the following questions, among others.
    • How many employees will be working there? Are they full-time or part-time? Will they be working in the leased space or off-site.
    • Will the number of employees vary over time?
    • What is the nationality of these employees?
    • What will each of these employees be doing in this rented space – will they be programming? consulting? buying? selling? manufacturing? providing customer support? managing other employees? something else?
    • Who are the customers of the business? That is, who will be paying for the goods or services provided by the WFOE?
    • What is the projected cash flow of the business? Where will income go (i.e., to the WFOE, to the parent, to an affiliated entity)? How will expenses be paid (i.e., directly by the WFOE, by the parent, by an affiliated entity, etc.)? Where will the WFOE get its money to operate?

The scope of business will also be used in the company name as noted in Question 4. above.

  • Feasability Study.  We must provide a feasibility study that states the basic business plan of the WFOE. Our staff will draft that document. In order to do this, in addition to the information requested in Question 6 above, we need the following information:
    • Statement of start up expenses in reasonable detail.
    • One year and five year proforma income statement and balance sheet.
    • Statement of what services/product the WFOE will provide (to the extent not addressed in Question 6).
    • Statement of the expected cash flow of the WFOE: what entities will pay and what will they pay for (to the extent not addressed in Question 6)
    • Initial staffing plan for the WFOE with a three year and five year projection. Of particular importance is the nationality of the staff (to the extent not addressed in Question 6).
    • Statement of the business opportunity this WFOE will exploit, the expected market for the service, how you propose to meet the needs of that market and the benefit to China from the project.
  • Registered Capital.  We must state the amount of the registered capital for the WFOE. This amount is the actual amount of capital that will be paid in by the shareholder as start-up capital for the WFOE. Registered capital is not a deposit: it is the actual operating capital used by the WFOE for payment of start up expenses such as rent, remodeling, equipment and salaries. There is no set number, since the amount required for each WFOE is different. As a rule of thumb, most Chinese regulatory authorities expect that registered capital will be equal to at least the first years expenses. Some districts have a minimum amount for registered capital. For example, districts in Shanghai generally require at least US $150,000 in registered capital. Note also that certain businesses will be required to have higher registered capital minimums. The rule is that all registered capital must be paid within two years after approval of formation of the WFOE. Fifteen percent of this amount, or the required minimum, whichever is greater, must be paid within 90 days after formation of the WFOE. The amount of registered capital must be considered carefully. Any amounts paid into the WFOE by the shareholder in excess of registered capital will be treated as income to the WFOE, and taxed as such. Accordingly, it is important not to set the registered capital number so low that you would encounter this problem. We will discuss this in more detail with you as we progress.
  • Management. WFOE can be managed through a) a board of directors or b) through a single managing director. For a board of directors, the number of directors is typically three. One director is selected as the representative director who has the right to enter into agreements on behalf of the WFOE. For the managing director, a single person is appointed as the managing director. This person is also the representative director. You will need to determine which management method you will use. For single shareholder WFOEs, the managing director approach is common. You will need to designate the following:
    • Directors.
    • If you will use a board, state how many directors. Provide the full name and address of each director.
    • If you will use a managing director, provide the full name and address of each director.
    • General manager.
    • The daily business of the WFOE will be managed by a general manager. This person can be a member of the board or an independent individual. The person can be a Chinese national or a foreign national. The person can be a resident of China or a non-resident. Typically, for a WFOE the general manager is a Chinese national who does not serve on the board and who is resident in China. However, there is no fixed pattern.
    • Supervisor.
    • The supervisor is responsible for supervising the conduct of the board in order to protect the rights of shareholders. In a one shareholder WFOE, the supervisor position is not necessary. However, Chinese law requires an appointment to this position. The person must be independent and cannot be a director or the general manager.
  • Documentation for each person.For each person above, provide the following:
    • Name and address.
    • ID: For non-Chinese citizens, we will need four color copies of their passport. For Chinese citizens, we will need four color copies of their national ID card.
    • Resume: one or two page, including birth information and address, signed, four originals.
    • Photos: four 2″ visa size photos.
  • Proof of financial status. Normally, this can be done through a letter from your bank stating the basics of your deposit relation with the bank. We will provide you with an approved form for this letter. In some cases, the Chinese authorities will require an audit of the investor company. We will determine as soon as possible whether such an audit will be required.

And the above is just for a typical WFOE.  There are going to be all sorts of variations, depending on the type of WFOE being formed and even on the city or district in which it is being formed.

Everyone always wants to know how long forming a China WFOE will take and we always tell our WFOE formation clients (before they retain us) that it typically takes from 3-6 months and that our primary goal is always to work as quickly as we can, but that whenever we are faced with a situation where we have to choose between doing something 100% right and doing it fast, we always choose accuracy and precision over speed. If your WFOE is rejected once, the odds of it ever being accepted go way down.

Sometimes potential (and even existing) WFOE formation clients tell us of “someone” out there claiming to be able to form a WFOE in “just a couple of months.”  To that, I always respond that every single reputable law firm (both Chinese and American and European) with whom I have spoken has told me that three months is their bottom line estimate for the time it takes to form a WFOE.  I am bringing all of this up now because at the Doing Business in China seminar, two lawyers from two different highly reputable law firms put on their PowerPoints how long it takes to form a China WFOE.  One put six months and the other put 4-6 months.  These are the figures from start to finish and include the 30-90 days it can take once all documentation has been submitted to the appropriate authorities.

If anyone is assuring you that they can do a WFOE formation in “record time,” run, don’t walk away.  Forming a WFOE in China takes time.  Months of it.

Believe it.

For more on forming a WFOE in China, check out the following:

What are you seeing out there on WFOE formations?

As costs in China continue to rise, we are seeing many more companies struggling to find well-priced space that qualifies for a WFOE. Let me back up a bit and explain.

One of the requirements for forming a Wholly Foreign Owned Entity in China is that there be a lease in place for the WFOE-to-be. The WFOE cannot just lease any space; it must lease space deemed appropriate for a WFOE.  What this really means, mostly, is that the space must be eligible for leasing by a foreign company and that the landlord of the space must be legitimate and willing to report the lease to authorities. In other words, the landlord must be willing to pay taxes on the lease. 

When lease rates were lower in China and space was easy to find, this requirement was seldom an issue. Lately, however, we are seeing many more companies that are struggling to find appropriate space and getting frustrated.

We now explain the situation to our new WFOE formation clients as follows:

The factory space must be legally owned by the landlord, must have all proper documentation and the lease must be registered with the local government real estate office. While this sounds simple, we find that many clients are looking for cheap space. Cheap space exists, but it usually means that there are problems with the documentation that make its use in a WFOE impossible.

There are many other issues related to factory leases and we will discuss those in more detail with you once you have found an appropriate space you wish to consider leasing. Often additional work must be done on the factory space and provision must be made for installation of equipment. This can sometimes be quite complicated, requiring additional care in the lease process. 

What are you seeing out there in terms of being able to find WFOE-appropriate space?

There are some excellent China company formation companies and there are some where you are all but guaranteed to waste your money.  Some of these company formation firms (truly, always the better ones) call my firm in to assist when they are facing a new or unusual or difficult situation. Sometimes a foreign company using a company formation company will call us in to assist when they become worried about their chances for WFOE formation success. Other times, we get called in to deal with the more legalistic aspects of a formation.

I mention all this because I recently was cc’ed on an email from co-blogger Steve Dickinson to a client experiencing difficulties with forming its China WFOE using a China company formation firm. Steve’s email provides a pretty good example of the typical issues involved in forming a WFOE and, stripped of any identifiers, it reads as follows:

At this point, I will need to review the following:

  1. Application for reservation of name;
  2. Feasibility Report together with supporting financial statements;
  3. Most recent proposed Articles of Association.

These three documents have to match, so review of all three at the same time is necessary.

With respect to your questions, let me know how you want to proceed. Do you want to provide me with a list of questions or do you want to schedule a conference call?

In terms of reviewing the application process, please let me know how you want me to proceed. I will need to know where you are in the process and what documents have already been prepared.

Usually I find that most clients have questions/problems with the following:

  1. Proof of existence of the U.S. shareholder. Appropriate documents must be authenticated by both the California Secretary of State and the Chinese consulate in San Francisco.
  2. Appropriate lease for the WFOE in China. In particular, for trading companies, the Shanghai authorities frequently insist on a warehouse space that can be quite expensive and possibly unnecessary.
  3. Registered capital. Shanghai generally insists on at least $150,000 in registered capital. For trading companies, certain districts insist on even more. The actual amount of registered capital depends on how the total investment is explained in the feasibility report. For this reason, the actual required registered capital may be substantially higher than the local minimum.
  4. Management structure: Board of directors or managing director. Who is the general manager and what will be its duties? Who acts as supervisor?

For trading companies, Shanghai usually imposes two additional requirements:

a. Audit of previous year’s performance for the shareholder. Closely held companies frequently do not have an appropriate audit report.

  b. Listing of customs commodity codes for any product to be imported or exported.

Employment is a separate issue not directly part of the company formation process. However, your WFOE will directly employ Chinese nationals. Since this process is quite different than the indirect employment you have been using for your Rep Office, your rep office experience is not likely to be transferable to your situation as a WFOE. A major issue in the employment area is protection of intellectual property and trade secrets with respect to employees. The employment issues should be considered now, so that you are ready to proceed when the WFOE is approved.

Let me know how you want to move forward on this project. I look forward to hearing from you soon.

We have never once had a WFOE application rejected in China and though past performance is no guarantee of future success, our past performance is based in large measure on how we work with the appropriate authorities before our clients get locked into something that may lead to a rejection of their WFOE application. Sometimes we have to go to the authorities multiple times to test out “ideas” before we actually submit anything. These idea testing conversations are done without our naming the company seeking to register.  Once an application has been rejected, for any reason, the chance of the company ever securing approval just went way down. What works for a trading company in Shanghai may or may not be relevant for a manufacturing company in Qingdao or a software company in Chengdu.

For more on what it takes to form a WOFE in China, check out “How To Start A Business In China — WFOE” and “How To Start A Business In China — The Minimum Capital Requirements For A WFOE.”