Yesterday, I wrote here about the questions our China lawyers ask our clients for whom we are forming a China WFOE. Today I step back a bit to focus on the issues that we deal with in determining whether a China WFOE makes sense for our clients at all. In future posts in this series I will focus on the nuts and bolts of what is involved in forming a Chinese company (including the minimum capital requirements) and in the final post, I will discuss the most common mistakes we see made when trying to form a Chinese company.
As China’s economy continues to slow, its tax crackdown on foreign companies operating improperly in China continues to accelerate. As difficult and expensive as it is to form a China entity (WFOE, Joint Venture or Rep Office), foreign companies doing business in China are increasingly realizing that not having an entity will in the long run cost them much much more.
Starting a business in China usually involves forming a Wholly Foreign Owned Entity or WFOE. Forming and getting a China WFOE up and running involves more than simply securing Chinese government approval for the new entity. It also usually implicates the following eight core issues as well.
1. Do you need a China entity at all? Forming and operating a China WFOE is expensive and time consuming. Therefore, no WFOE should be formed unless truly necessary from a legal or a business standpoint. For this reason, the first thing our China attorneys do when retained to form a China WFOE formation is to work with our client to determine whether a WFOE is truly necessary. For more on this, check out How To Manufacture In AND Sell In China Without A WFOE.
2. Will your WFOE even be legal? There are still many industries in China in which a WFOE is not allowed, but a joint venture is. And sometimes, though incredibly rarely, a Representative Office (Rep Office) makes sense. See also this article I wrote for Forbes: Do This One Thing Before Doing Business In China.
3. Should a Hong Kong company own your China WFOE? Forming a Hong Kong company to own a China entity depends on the specific situation. The decision usually comes down to whether creating a Hong Kong company for our client will save it money or just create additional hassles. For more on whether it makes sense to use a Hong Kong parent company, check out How To Form A China WFOE: Hong Kong Parent Company Is Optional.
4. How should you describe your WFOE’s scope? If the scope of the WFOE is too narrow, it will not be able to do all that it wants to do in China. If the scope is too broad, WFOE formation will be denied. It truly is a Goldilocks situation. For more on this, check out How To Form a China WFOE. Scope Really Really Matters and How To Form a China WFOE. Scope Really Really Matters, Part II. It is critical that you get this right as Beijing does not hesitate in shutting down WFOEs after their formation for getting this wrong.
5. What is the appropriate amount of minimum capital? This too is a Goldilocks situation that usually has a lot more to do with our client’s present and future finances than it does with any Chinese government requirement. For more on this, check out How To Start A Business In China. The Minimum Capital Requirements For A WFOE, Part II — The Goldilocks Rule.
6. Is your lease suitable for a China WFOE/Does your location make sense? If the lease is not suitable, no China company can be formed. For more on this, check out China WFOE Lease Reviews. Choosing the right location for your China business implicates legal issues as well. With an office, this is usually relatively easy, but with something like a retail establishment, it can be a big issue. You typically do not want your official business location to be the same as your initial retail location because if you end up wanting to close down your initial retail location, you will then have to deal with the added hassle of needing to secure approvals from the Chinese bureaucracy to change your business location. There are also all sorts of issues that can arise from having a location in one place and your employees in another.
7. Are your employment documents in order? If you are going to have a Chinese entity with employees, it is critical that your employment documents be in order. This includes mandatory documents such as labor contracts and company rules and regulations, as well as optional documents such as confidentiality agreements, non-compete agreements, and educational reimbursement agreements. For more on China employment law check out China Employment Law: It’s Complicated And It’s Localized.
8. Is your IP protected in China? This typically begins with figuring out what can and should be done to protect trade secrets, trademarks, copyrights, and patents, and then drafting appropriate contracts and provisions with vendors, suppliers, counter-parties, and employees to protect that IP. This also usually involves figuring out what IP can and should register in China as a trademark, copyright, or patent. For more on China IP protection, check out How to Protect Your IP From China. Nine times out of ten, it makes sense to shore up your IP before you register your Chinese entity.
If you have your ducks in a row on these eight issues, you should be well on your way to starting a business in China.