China company 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

I spoke last week (for ten minutes) in Atlanta at NACA’s First Annual US-China Business Conference. I posted that speech (the written version of it, anyway) in a post entitled China Legal Issues For Business. The Ten Minute Version. In going through and deleting old emails today, I came across my first, very different version of the speech. Initially, rather than deal with an overall general approach to dealing with Chinese legal issues, my plan was to speak really fast and highlight specific legal issues relating to foreign business in China. Here is the outline I was going to use for that sort of speech, before I concluded it would be too legalistic, boring and scatter-shot:

1. Company Formation

  • Is it legal?
  • Spend AFTER Chinese government knows you are forming.

2. Contracts

  • Who’s your counterparty?
  • Spend a little, save a lot. Be diligent with your Due Diligence.
  • Arbitration is the only solution, except when it’s not.
  • How to get your Christmas lights before Christmas.
  • Contract language/Arbitration language

3. Intellectual Property

  • Register early and often, except patents
  • NDAs are not DOA
  • It’s more than just legal.

4. Joint Ventures

  • Why, why, why? The Peoria test.
  • Control is always critical, yet nearly always illusory.

5. Labor Law

  • How does lifetime tenure for everyone sound?
  • How does overtime for nearly everyone sound?
  • Written contracts for everyone.
  • Employer manual for everyone, to include FCPA and trade secret language

6. Choosing Your China Lawyer

  • English and Guanxi are overrated.
  • Lawyer ethics and confidentiality. Be careful.

7. The law is everything and nothing

  • Ex post facto. Sure, why not?
  • Obsolescence at warp speed.
  • You are not Chinese and you never will be.
  • Assume law in China is nothing like the U.S/Assume it is similar.

Think I’ll use this the next time someone wants me to speak for thirty minutes….

 

 

We received an email today from a China consultant with whom we have worked in the past. This consultant has a client who wants to lease a factory in China:

We have a client whose business is exporting ___________ materials from China mostly to Eastern Europe. His clients are big __________ plants who always have plenty of potential suppliers in line, so quailty for him is crucial. 

His current Chinese suppliers often try to reduce costs by buying bad quality raw materials and their equipment is not really up to date either.

His sales are growing rapidly and he wants to rent a factory somewhere in China, put in top of the line equipment and implement high quality production.

I remember somewhere in Chinalawblog you or Dan mention your firm often deals with factory rent.

What process will be client need to go through to accomplish this in China?  

Steve responded as follows:

The only legal way a foreign company can rent and operate a factory in China is to create a legal entity like a Wholly Foreign Owned Entity (WFOE) or Joint Venture (JV) to do so. Creating a WFOE is by far the most common way and this is a common next step for companies in your client’s position.

Creating a WFOE is a standard process and we do those all the time.  

The factory lease is a separate matter from WFOE formation. It can be quite a complex process, though we do those all the time also. The details depend on where the factory will be located. The main problem our clients encounter in leasing a factory in China is that they often try to rent factory space that cannot be used for a WFOE. For factory space to qualify legally for a WFOE, the factory space must be legally owned by the landlord and it must have all proper documentation. On top of that, the lease must be registered with the local government real estate office.

Though this sounds relatively simple, we find that many companies are looking for cheap space. Cheap space definitely exists in China, but cheap space usually comes with documentation issues that make its use in a WFOE impossible. There are many other issues related to factory leases. Often additional work must be done on the factory space and provision must be made for installation of equipment. This can often be quite complicated, requiring additional care in the lease process. Finally, many of the details on WFOE formation depend on the location of the factory.

If you would like to discuss further, please let me know.

For more on what it takes to form a WOFE in China, check out the following: 

I am always saying that for every 100 China WFOEs and Joint Ventures my law firm helps set up in China, it does one representative office. Why so few, when it is generally agreed that representative offices are the easiest type of offices for foreign firms to set up in China? Because the inherent limitations on China Rep Offices mean they seldom make sense.

Rep Offices “represent” in China the foreign company back home. Rep Offices are not a separate legal entity; they are the China representative of the foreign company. Most importantly, they are not allowed to engage in profit making activities. Chinese law limits them to performing “liaison” activities. They cannot sign contracts or bill customers. They cannot supply parts and after-sales services for a fee. NOTE: This post does not discuss branch offices for banks, insurance companies, accounting and law firms, that are permitted to engage in profit-making activities.

Rep Offices are pretty much limited to engaging in the following:

  • Conducting research.
  • Promoting their foreign company.
  • Coordinating their foreign company’s activities in China.
  • Other activities that do not and are not intended to generate a profit.

Because forming a Rep Office in China is faster, cheaper and easier than forming a Wholly Foreign Owned Entity (WFOE), companies oftentimes consider forming a China Rep Office as a way of “putting their toe into the water” there. These companies typically intend to switch over to a WFOE once it becomes clear China will be viable for them.
My firm generally discourage this “Rep Office and then a WFOE plan” because “switching” from a Rep Office to a WFOE is not really a switch at all. Making that switch in China will involve both shutting down the Rep Office and then forming a WFOE pretty much from scratch. Because the cost of forming a Rep Office, shutting down the Rep Office, and forming a WFOE, will be considerably more than just forming a WFOE, forming a Rep Office with the later intention of forming a WFOE does not usually make sense and most companies will be better off just biting the bullet and forming the WFOE straight away.

Other times, companies have come to my law firm believing they need a China Rep office because they need a Chinese entity to sell their product into China. Oftentimes these companies can sell their product into China without having to create any in-china footprint at all. So long as they are not going to have much need for people in China, they oftentimes can get away without forming a company in China at all.

But there are definitely times where a Rep Office makes sense. By way of one example, my firm set up a Rep Office for a US company that sells US made equipment for around $2 million each. This company has no plans to start manufacturing its equipment in China so there would be no need to form a WFOE for that. It already had an arrangement with a Chinese company to repair its equipment sold into China, so no need to establish a WFOE for that purpose either. This company merely wanted an on the ground China presence to improve its sales and to let its customers and potential customers know it is serious about China.

China Rep Office applications typically go through the Administration of Industry and Commerce (“AIC”), though some industries (banking, insurance, legal, accounting, airline, media, and some others) also require an additional approval from the Chinese government agency with jurisdiction over that particular industry. All applications must be submitted by a designated/authorized Chinese agent (often known as a Foreign Enterprise Services Company or “FESCO”) in the locality where the proposed representative office is to be established.The application involves submitting fairly standard corporate documents from the foreign company, along with a copy of the lease agreement showing the Rep Office is leasing legitimate business space in China.

MOFCOM usually takes around thirty days to approve a Rep Office. One interesting feature of China Rep Offices is that they are not permitted to hire employees directly; they must be staffed indirectly through a FESCO. Nonetheless, it remains the responsibility of the Rep Office to make sure its FESCO employees have signed off on Rep Office company policies, including on such things as confidentiality. In all instances where we have formed a China Rep Office for our clients, we also have drafted the employment agreements the FESCO must use with the employees. That way we can be certain the agreements best protect our client.

For more on Rep Offices in China, check out the following:

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.” 

 

 

Inc. Magazine just came out with an article today that does a nice job setting out the basics for foreigners starting a business in China. The article is by Issie Lapowsky and it is entitled, “10 Steps to Starting a Business in China.” 

Its ten steps are as follows. I have tried to pull the best parts, but I have to admit to a bit of bias towards those portions that quote me the most.  So if you want the full story (and you should), I urge you to read it here.   

1. Do your homework.  Hard to argue with this. 

2. Pick a location.  Yes.   

3. Choose an entity:  

Before you register with the government, you need to decide what type of business entity to register. The most common for foreign businesses are joint ventures, representative offices, and wholly foreign owned enterprises. Each, of course, has its pros and cons.

A joint venture requires a partnership between a foreign business owner and a Chinese citizen. Though joint ventures may sound like the safest route, experts warn against them. Critics say the most common problem with joint ventures is no more than a classic case of “same bed, different dreams” syndrome.

“They fail nine out of 10 times. You’re working with someone who’s familiar with the territory on their turf, and they will end up with the business,” Harris [that’s me!] says.

Representative offices are an easy, low-cost way to go, but it drastically limits the scope of what you’re allowed to do in China. As Yang says, “A representative office is just there to represent your offshore entity.” In other words, you cannot deliver any services or products, which means you also cannot generate revenue. A representative office affords you little more than the ability to show your face and build your brand name.

The most common type of entity, therefore, is a wholly foreign owned enterprise, known as a WFOE. According to Frisbie, “75 percent of American investment in China these days is 100 percent American-owned facilities,” because it gives business owners maximum quality control.

Not surprisingly, though, a WFOE is much more complicated to set up. It takes more time to get approval from the government, and it requires a minimal capital investment that you must put in a Chinese bank. Harris says. And, he notes: “That amount can vary greatly depending on the nature of your business and where you’re setting it up.”

4. Develop a business plan; 

A detailed five-year business plan is crucial, because once the government approves it, you will be able to operate only within its guidelines. If you start offering a product or service that is not in your business plan, the Chinese government can shut your business down. The same goes for where and how you operate.

“Make sure your business plan is as broad as possible to allow the company to operate freely,” says Collins. “U.S. companies expect to operate in a certain way here and they realize their business license may not allow them to do that.”

While it needs to be broad, it should also be specific. Make sure you include your location, projected revenues, product or service description, expected number of employees and budget requirements in the plan.

It’s also wise to tailor your plan to China’s five-year plan.

“If you’re making a high-tech piece of lawn equipment, and you just apply saying, ‘I’m going to be making lawn equipment,’ they’re not going to look at you very favorably,” says Harris. “But if you say I have this new, software-driven, high-tech piece of lawn equipment that’s going to put 20 software engineers in China to work right away, then it’s a different project.”

5. Find a liaison … or several:

A qualified liaison should be able to tell you where you need to go to register [your business], whether it’s the local, provincial or national government, and should do the talking once you get there. Harris says, “You need somebody who has negotiated that territory a number of times before and you absolutely have to have people who speak Chinese to go meet with the local officials.”

6. Organize the necessary documents:

“There are the written laws in China and then there’s the reality on the ground,” says Harris. Nowhere does this theory apply more than when it comes to what documents you’ll need to register.

  *      *      *      *

Always prepare for a wildcard, though. “We’ve had local authorities say they want to see exactly what it will be we’re manufacturing, so we bring it in,” Harris says. “We just did one, and they required we write a legal opinion explaining how LLCs worked in the United States. We’d never had that before, but when it happens, don’t fight with them, because you’ll lose, and you’ll waste time.”

7. Trademark your intellectual property:

Intellectual property violations are a big issue for foreign investors in China. Many U.S. manufacturers believe that because they have a trademark at home, it will hold up in China, but that’s not the case. In China, the first person to register a trademark owns the rights to it, regardless of whether or not that person is the first person to use the trademark.

“Somebody could go register what you thought was your trademark,” Harris says. “Then, when you’re about to ship $3 million worth of product, and your product’s held up at the port, you get a phone call from someone saying, ‘You’re using my trademark, and I’d like to sell it to you for $300,000 a year.’ If you don’t pay them for the trademark, your goods will never leave China.”

8. Find a bank: 

This part should be quick and easy, since there are plenty of banks with a huge presence in China. Try HSBC, which is based in Hong Kong, or Bank of America, which you can find all over the country.

“If you’re dealing with a bank that doesn’t have any relationship with banks in the United States, it makes it tough to keep track of your money,” says Wong. “You want to make sure you have a bank in the United States and a bank in China that has some sort of corresponding relationship, so your banking is more transparent.”

9. Hire a staff: 

Hiring in China is a delicate process, especially when it comes to hiring managers. Don’t assume that just because a person’s English is impeccable they’ll be able to run the business properly.

“If all things are equal,” Frisbie says, “the language skills can be greatly beneficial, but it’s far more important to have a smart business person in that role who’s going to run the company the way you want it run.”

 *   *   *   *

Once you have trusted managers in place, they should be able to assist you in hiring the rest of the staff. Remember, though, you need to have a contract for every employee you hire, as well as an employee manual. Without either, says Harris, “it may become nearly impossible for you to fire anyone.”

“In China, you need a reason to fire someone,” he explains. “That reason needs to be set down in your employee manual, otherwise your ex-employees can sue you for a lot of wages.”

10. Take it slow: 

Don’t jump into quick business deals just to turn a profit. It takes time to build business relationships over there. “It’s much different than the U.S. in regards to the amount of time that’s spent developing the business relationship before the actual deal is consummated,” says Wong.

What will win you success in the Chinese market is patience. “The Chinese have been doing business in a certain manner for thousands of years. Don’t even start to think for a millisecond that you’re going to change it.”

What’s the eleventh step?   

“Steal a little and they throw you in jail. Steal a lot and they make you king.”

Bob Dylan
Guanxi either retires or goes to jail.

Rich Brubaker
Just read an absolutely fantastic china/dvide post, written by Damjan DeNoble. The post is entitled, “Kro’s Nest, End of Days” and is it in on how a very well known Beijing expat, “Kro” of Kro’s Nest restaurant fame had his restaurant mini-empire “taken” from him by his Chinese “partner” (the words “taken” and “partner” are in quotes to show a lack of any real legal meaning). For some more background on Damjan’s relationship (in better times) with the Kro’s Nest, check out this post, “Getting All Personal About Doing Business In China.
I don’t know Kro and I don’t have a clue what went on with him and his Chinese “partner,” beyond what I have read in this article. But I (like just about every other lawyer who represents businesses) have a ton of experience with partnership disputes (broadly defined) and I am guessing that if I had gathered up the facts and written the article, it would have been very different. My article would have focused on one thing and one thing only –and it would have admittedly been way less interesting than Damjan’s article for having done so.
My article (like this post) would have focused on how what appears to have happened here has happened so many other times that lawyers do not even like talking about it. What happened here was a bunch of oral agreements by two people who never got around to legally formalizing their relationship. And then things changed (as they always do) and the partner with greater power took the business from the “partner” with less power. In this case, the Chinese national is ending up with the business because the business is on his “turf.”
Again, this sort of thing happens ALL THE TIME ALL OVER THE WORLD. Ask any lawyer who does business law about this sort of thing and then watch them roll their eyes. If they have been practicing a few years, they will almost certainly have their own emotional story to tell. If they have been practicing longer, they will probably just walk away. Too many stories to tell, none all that different. None all that surprising. And too commonplace even to get all emotional about.
Here is where we lawyers differ from the rest of the world.
We lawyers believe every single deal may end up going bad and we want to draft agreements/contracts to deal with that eventuality. Real people believe their friendship/common business interests will carry the day and that the goodwill that has started the business will be there next year and next decade.
I had a great talk the other day on this topic with a Michigan lawyer with whom I am working on a China matter. He told me of his having formed a domestic company in which the two owners insisted everything be done by consensus. The owners refused every lawyer entreaty to put anything in their agreements about how to resolve ownership disputes. The two owners spent millions on the business, and then, unbelievably quickly, they started disagreeing on virtually everything. The business stagnated and without any mechanisms in place for dealing with disagreements, they ended up selling out for pennies on the dollar.
I told this lawyer my recent story of a very prosperous U.S. company that had been formed maybe 15 years ago by an American and a Russian. It started small with no written agreements between them and then it grew really big and really international (Russia, Korea, China, Japan, Vietnam), but still with no written agreements between them. Then disputes arose between the two owners and then the Russian sued the American for millions of dollars and then the case took three years and then my firm won the case at trial and then the Russian appealed and we are now waiting for the appellate court’s decision. You can read more about that case here and you can listen to the appellate oral argument here.
Not that long ago, I had a guy in my conference room break down and cry because his business in China had been “taken” from him in a situation not all that different from that described in Damjan’s Kro’s Nest article. This person said that in addition to having lost nearly all his money, what really got to him was the realization that he had wasted the last five years of his life killing himself to build up a business he loved and now it was gone, right when it had “really started to take off.” I didn’t have the heart to tell him that these sorts of things always happen right when the business has just taken off. The sad reality (again, which we lawyers know all too well) is that people fight way more often over a valuable business than a failing one. With failing businesses, disputes among the owners often just lead to one or both of them walking away.
Anyway, I urge you to read Damjan’s post as a classic cautionary tale. And on behalf of lawyers everywhere, please do consider listening the next time you feel your lawyer is being too cautious.
For similar examples, check out the following:
Take A Time Out On Foreign Publishing In China
That’s China and It Ain’t Always Pretty
That’s China And It Still Ain’t Pretty, But Now It’s Better Explained
UPDATE: Just learned from the Adam Daniel Mezei blog that Beijing Boyce also did a nice piece on the Kro’s troubles and two excellent points:

While I have not talked to all of the players in this situation, I would make two general points. One, in a city where it seems like half of the foreigners I know want to open a bar, cafe, or restaurant, this is yet another case that shows the importance of getting your legal house in order from the start. Two, while this is a conflict between an expatriate and a Chinese, I have seen problems arise between Chinese partners and between expatriate ones. In other words, problems can arise regardless of nationality when money is involved. Both of these points sound obvious, but…

UPDATE: In a post entitled, “Kro’s Nest roundup,” the Heart of Beijing blog nicely summarizes the various articles/posts on this issue,

Around 25% of my law firm’s China legal work is done with US or European attorneys, and a good chunk of that work is helping them help their own clients form a Wholly Foreign Owned Entity (WFOE) in China. The law firms that retain us do not have their own lawyers in China but because the China work they are doing for their clients is just one part of their work for that client, quite logically, they want to coordinate that work with whichever China lawyers they retain.

We recently took on three new WFOE formation matters for US lawyers. Two of these matters are for lawyers working on behalf of their clients and one is for a lawyer who owns the (non-law related) business. All three of these lawyers told me they had spoken with company formation firms and had grown frustrated with the information they were being given.  They relayed that these firms were not giving clear answers to many of their questions, but were instead responding by saying China WFOE laws were “vague” and/or “ever changing.”

What these company formation firms are saying is just not correct.

Chinese law on WFOE formations is actually quite clear and I suspect these company formation firms were claiming otherwise only because the laws are vague to them. Near as I can tell, these company formation firms typically consist of a foreign voice or two (oftentimes in Hong Kong) who takes in the work and then farms it out to a Chinese law firm in a low cost city to do the work. The people on the phone or at the other end of the e-mail at these firms have never read China’s laws on WFOE formation and so, not unexpectedly, those laws are vague to them.

As for “ever changing,” on January 1, 2006, there was a sea change in China company formation laws for foreign companies, but they have remained static since then.

By far the biggest source of confusion/frustration for these US and European attorneys seeking information on forming a China WFOE is the minimum registered capital requirement.

The law on minimum registered capital is clear, but the amount of capital that will be required does vary, depending mostly on the nature of the business of the company to be formed and on the city in which it is going to be registered.

Every company in China must have a stated registered capital. The registered capital includes all of the components of the initial investment in the company, including its start up cash, contributed property, and transferred intellectual property.

Where the registered capital is small, the entire amount must be contributed immediately upon formation of the company. If the amount is large, it may be contributed in installments. There are a number of schedules for the percentage and timing of large amounts of registered capital.

It is a crime to state a registered capital amount and then fail to contribute. It is also a crime to withdraw registered capital after it has been contributed.

The purpose of registered capital is to provide some notice to creditors of the capital adequacy of the company. Because of this, Chinese regulators take very seriously the rules regarding registered capital.

Registered capital is an initial investment that is intended to be immediately used in the operation of the company. It is not a deposit that must just sit in a bank and never be touched. It can be used to pay salaries and rent, to purchase product, or for any other normal start up operating expense. Registered capital may include contributed real and personal property used in operating the business. Many foreign investors think registered capital is some sort of security deposit that they can never utilize. This is not true.

On the other hand, some foreign enterprises believe they can simply withdraw their registered capital to their home country after the Chinese company begins normal business operations. This also is not true. The only way to get funds from the Chinese company out of China is by repatriating profits or by liquidating the Chinese company. Both of these methods will work, but they both require paying Chinese taxes and meeting other requirements under Chinese law.

Investors should also note that the RMB is not a freely convertible currency. For companies that will earn RMB income, the issue of conversion to U.S. dollars or other foreign currency should be carefully considered.

Chinese law is quite clear regarding minimum capital requirements for a WFOE but the statute’s prescriptions on this are essentially meaningless in actual practice. Under Chinese Company Law, the minimum capital requirement is either 30,000 RMB (less than $4,000 US) or 100,000 RMB (a bit over $12,000 US) depending on whether it is a multiple or single shareholder company. However, these numbers have no real meaning for forming a WFOE in China.

The real question is what the Chinese authorities will consider as adequate capitalization for the specific project and that always depends on the type of business and its location. For example, it is very expensive to operate a business in Shanghai. On the other hand, it can be very inexpensive to operate the same business in a rural part of China. It is expensive to operate a capital intensive business like manufacturing, but relatively inexpensive to operate a knowledge based consulting business. Finally, some Chinese cities just seem to want WFOEs more than others.

The Chinese regulators usually consider all of these issues. To complicate matters, each local regulator has its own basic standards on what constitutes adequate capital for certain types of business activities. These numbers are not published, but when asked they will almost always be provided. They can only be determined through direct contact with the regulator but only after providing a clear explanation of the project.

The local regulator virtually never considers the statutory minimum in making a determination regarding adequacy of capital. Rather, the local regulator will determine what it believes is an adequate amount of capital based on all the circumstances. Once the investor has a clear idea of the outlines of a project, it is usually a good idea to engage a China attorney to contact the local regulator to see what their response will be to the proposed amount of investment. This initial screening can save a lot of time if the investor’s idea of the proper amount of capitalization is dramatically different from that of the local regulator.

My firm’s China attorneys always go to the local regulators to get this amount before we get very far along in the application process. Almost without exception, our experience has been that after we explain the nature of our client’s business to the regulator, the regulator’s decision on the minimum capital required has been a very workable one for our clients.

In determining what constitutes adequate capital, one needs to consider the peculiar situation in China that all rents are paid in advance, that payment for products for sale are usually paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up cost is going to be higher than for a comparable company in the United States, where credit and time payments are much more common. Chinese regulators will not approve a project that looks risky or under-funded.

Are we clear?

As our regular readers know, we are big fans of foreign companies entering China as a Wholly Foreign Owned Entity (WFOE).  We blogged on this initially in “China WFOE v. JV” and then again in “To Succeed In China Know The Now.”  In “Chinese Company Formation — Forming a Wholly Foreign Owned Entity (WFOE) in China” and in “Chinese Company Formation, Part II — WFOE Minimum Capital RequirementsSteve set out the logistics and the requirements for forming a China WFOE.

The Tri-Valley (California) Herald recently ran a nice story [link no longer exists] on the Dahlin Group, a small, local, architecture firm that has had considerable success in China.  I love this story because it puts facts to the following four things we are always saying:

  1. China is booming. Go there for growth.
  2. China’s service sectors are particularly hot.
  3. Small businesses, particularly service businesses, can thrive in China.
  4. WFOE is the way in China.

If you are a small service business thinking of expanding to China, I suggest you read this article.  Though I am certainly not saying that the Dahlin Group’s China entry path is the only way to do things, I am impressed with this company’s vision and its measured approach to China entry and business.

I also suggest reading my much longer post entitled, “Doing Everything Right in China — A Danfoss Primer,” describing the steps taken by a medium sized manufacturing company to succeed in China.