At least once a month, one of our China lawyers will get a call from someone asking us to form a “China company” for them before they start doing business in China “next month.” Half the time when we get this sort of call, the better solution is not to form a China entity at all. The other half of the time, the problem is that forming a China company typically takes at least four months and after you finish reading this post you will understand why.
American lawyers often take on domestic company formations as a loss leader because the work tends to be fast and easy and they expect that the firm will get additional legal work once the company is formed. With China company formation, I often joke that the process is so onerous that our client never wants to speak with us again after we finish.
This post focuses on forming a Wholly Foreign Owned Entity (WFOE) in China because this is by far the most common entity formed for foreign companies doing business in China. I would estimate that of the last 200 companies my law firm has formed for American companies in China, 180 have been WFOEs, 18 have been joint ventures, and two have been representative offices. (And the joint venture numbers are only that high because one of our China lawyers is so well known for his joint venture expertise.)
The steps for forming a WFOE in China typically initially consist of the following:
1. Determining if the proposed WFOE will conduct a business approved by the Chinese government for foreign investment. China remains closed to foreign companies engaging in certain types of business, and regularly issues a catalog detailing which industries are open to foreign investors, and under what constraints. For some industries, foreign investment is only allowed via joint venture.
2. Determining if the foreign investor is an approved investor. In theory, any legally formed foreign business entity is authorized to invest in a WFOE in China. The investor must provide documentation from its home country proving it is a duly formed and validly existing corporation, along with documentary evidence identifying the person from the investor authorized to execute documents on behalf of the investor. The investor also must provide documentation demonstrating its capital adequacy in its country of incorporation.
To meet these requirements, the following documents are normally needed from the investing business entity:
- A copy of a Certificate of Good Standing (or equivalent document) that has been certified by the issuing Secretary of State (or equivalent), authenticated by the Department of State, and then authenticated by the Chinese Embassy.
- A copy of a Business License (or equivalent document identifying the investor’s directors and officers) that has been certified by the issuing Secretary of State (or equivalent), authenticated by the Department of State, and then authenticated by the Chinese Embassy.
- An original bank letter attesting to the investor’s sound banking relationship and account status.
- A copy of the passport of the investor’s signatory.
- A description of the investor’s business activities, the most recent annual audit, and supporting materials such as documentary proof of the investor’s involvement in the selected industry for at least three years.
Depending on the Chinese city of incorporation, some or all of the above needs to be translated into Chinese or summarized in Chinese.
Many investors create special purpose subsidiaries (often in Hong Kong) to serve as the investor in China. Though the Chinese regulators have become accustomed to this process, they will still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise; investor secrecy is not an option in China. However, the corporate register for the Chinese company will merely state the name of the foreign, special entity investing company as the owner. In that sense, as far as public disclosure is concerned, investor privacy can be maintained.
3. Chinese government approval for the project — that is, the work which the WFOE proposes to undertake. In China, unlike in most countries with which Western companies tend to be familiar, approval of the project by the relevant government authority is an integral part of the incorporation process. If the project is not approved, no incorporation is permitted. The two are inextricably linked.
The following documents must be prepared for incorporation/project approval:
- Articles of Association. This document should set out all details of management and capitalization of the WFOE. Nothing can be left for future determination. All basic company and project issues must be determined in advance and incorporated in the Articles. This includes identifying directors, local management, local address, special rules on scope of authority of local managers, and the amount of registered capital.
- Feasibility Study. The WFOE will not be approved unless the local authorities are convinced it is feasible. This usually requires a basic first-year business plan and budget. We typically use a client-produced business plan and budget as a model for drafting a feasibility study (in Chinese) that will satisfy the requirements of the Chinese approval authority.
- Lease. Most Chinese cities require the investor provide an executed agreement for all required leases. This means an office lease as well as (depending on the industry) a warehouse/factory lease. It is customary in China to pay rent one year in advance and this must be taken into account in planning a budget because the governmental authorities will be expecting this. Moreover, each lease must be for a space that is suitable for the proposed industry and approved for use by a foreign-invested entity. The investor must also provide documentary proof that the landlord owns or controls the property and has a business scope enabling it to rent out the space. We oftentimes spend weeks confirming that our client’s proposed space can work for a WFOE.
- Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, one must at least specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from 35% to 40% of the employee base salary, depending on the location of the business. Foreign employers are held to a strict standard in paying these benefit amounts. The required initial investment includes an amount sufficient to pay salaries for a reasonable period of time during the start up phase of the Chinese company.
- Passport, photos, and résumé of the WFOE’s legal representative, and sometimes of other named directors and officers.
- The Chinese name of the WFOE. This must include the WFOE’s business scope.
- Any other documentation required for the specific business proposed. The more complex the project, the more documentation that will be required.
All of the above documents must be prepared in Chinese.
It usually takes two to five months for governmental approval, depending on the location of the project and its size and scope. On large and/or complex projects, the approval process often involves extensive negotiations with various regulatory authorities whose approval is required. For example, a large factory may have serious land use or environmental issues. Thus, the time frame for approval of incorporation is never certain. It depends on the type of project and the location. Foreign investors must be prepared for this uncertainty from the outset.
All of the above documents must be submitted to the authorities in the specific district in the city in which the WFOE will be located. This means that the investor must find office/warehouse space and sign any required leases before it can even begin the application process.
The above is the agony. The ecstasy is when the company is finally approved, which, believe it or not, happens pretty much every time so long as the American company does all of the above correctly.