How to Start a Business in China

Companies seeking to form a WFOE in China are often confused about Chinese law regarding the minimum registered capital requirements for forming a WFOE.  Part of the confusion stems from disreputable entity formation companies that encourage their hiring by claiming they know exactly how much will be required and that they have the ability to get the Chinese government to agree to a really low amount.

Under Chinese law, anyone forming a WFOE typically must put up a minimum of about USD $15,000 as a registered capital requirement.  What exactly does this mean?  Well, first off, the $15,000 is a minimum, but many Chinese cities have their own, much higher, minimum threshold.  In fact, virtually every city in which foreign investment is common has a much higher minimum capital requirement.  We just did a consulting WFOE in Qingdao and the capital required was about USD $80,000.  We also just did a consulting WFOE in Shanghai for which around USD $150,000 was required.  Our most recent Beijing WFOE needed around USD $300,000, but that was for a software development company.  The amount of minimum capital required is going to depend primarily on the city and the nature of the business.  Just by way of example, we did a WFOE not that long ago in not all that big a city but because of potential food safety and transportation risks, the minimum capital required was in the millions of dollars.  To a certain extent you just never know and anyone who claims to know before engaging in serious and substantive discussions with the right governmental authorities is just guessing.

But here’s the most important and least understood thing you need to know about China’s minimum capital requirements: the lowest amount possible is not necessarily what you will want.  Contrary to what many believe, the minimum capital required to go into a Chinese bank to secure a China WFOE is not frozen; you can use that money to fund your operations almost right away.

And that really matters. It matters because instead of seeking the lowest minimum capital required, you should be seeking the “just right” amount of minimum capital. In other words, the disreputable entity formation companies that seek to woo you with promises of securing you an ultra-low minimum capital requirement will almost certainly do you a disservice if they actually succeed — which they might as there are some cities in China where USD $15,000 will be enough.  But what can be so bad about only having to put in a small amount?  Surely you can put more in later if you need to do so, right?  In theory, you can, but it will no doubt cost you a lot, either in legal help in getting approval for a new registered capital amount or in taxes.

If you do not have sufficient capital to operate, you mind find yourself having to shut down. For good.  I have heard of that happening. The problem is that getting money over to China is not always easy and if you send that money over as anything other than registered capital, your China WFOE will get taxed on it as income, which is exactly what it will be. Alternatively, you could apply to have your registered capital increased and then send the money over as that, but we hear that takes at least two months, usually considerably more.  My firm has actually never been involved in such a transaction (knock on wood), in large part because we make sure that our clients understand registered capital ramifications when we first register their WFOE for them.

In fact, there are all sorts of things that some local governments tie to a WFOE’s minimum capital, including the following:

  • Temporary Residence Permits. Some local governments do not allow WFOEs with “too low” minimum capital to sponsor temporary residence permits for their local employees that have their Hukou in another city.
  • Expat Employees. Some local governments link the registered capital amount to the number of foreigners allowed to be employed by the WFOE.
  • Future Branch Office. The potential for securing approval to open a branch office is oftentimes lower if the registered capital is “too low.”

Calculating the registered capital for your WFOE at its inception is the key to avoiding costly problems with it down the road. For more on the minimum capital requirements for a WFOE, check out How To Start A Business In China — The Minimum Capital Requirements For A WFOE.

 

Not sure why (the bad economy?) but we have been getting a rash of China joint venture deals and possible deals over the last six months or so, many of which involve a United States company wanting to enter into a Joint Venture with their China manufacturer so as to work jointly on manufacturing and marketing and selling some combined product or products around the world.

One of the mistaken assumptions we are finding the American company is making is that it can contribute existing China-based equipment to this sort of equity joint venture (EJV) and receive “credit” for doing so.  Virtually every time, the American company is getting this wrong based on the bad advice of its putative Chinese joint venture partner.

Chinese law mandates that foreign companies doing equity joint ventures contribute a certain amount of capital to the joint venture.  Then, the voting power of each joint venture partner is proportionate to the capital each partner put into the joint venture. Since the foreign partner usually wants to control the joint venture it must contribute more than 50% of the capital to the venture. Since manufacturing operations are usually quite expensive, this means that the U.S. partner must make a significant capital contribution.

To avoid having to come up with the typically very large capital contribution required the U.S. side has been telling us: “We know the capital amount is large. But don’t worry about it, we have that part covered.” When we ask what they mean and what they will contribute as capital to the joint venture, their reply is “the equipment and molds and tooling we purchased and then placed in the XYZ China factory and have been using for the past year. XYZ acknowledges that we own these items and that we can just contribute them to the joint venture at full value. So we have the capital contribution problem already solved.”

Unfortunately, this does not solve the problem at all because China’s rule on foreign contributions to a joint venture (the same is true with respect to WFOEs as well) is that the capital contribution must come into China from outside China for the China Joint Venture.  Under Chinese law, it is very unlikely that the U.S. side has any ownership in equipment and tooling that is located in China. However, even if the U.S. side does actually own such items, they still cannot be contributed to the joint venture by the foreign partner because the foreign side of a China JV is not permitted to use RMB, cash, equipment and other goods, land or intellectual property that is located in China as its capital contribution to the JV. This is a black and white rule and there are no exceptions.

As we note above, the same rule applies to WFOEs in China. It takes an agonizingly long time to form a WFOE in China and we often get contacted by companies that have “jumped the gun” and started their China business operations before forming the WFOE. In doing that, they enter into leases and purchase equipment required for these operations. Consistently, they will want to contribute the lease payments and equipment (or the equipment costs) to the WFOE as a credit to the amount required for their capital contribution. For the same reasons discussed above, this is impossible because those contributions did not come into China from outside China for the WFOE.

For more on what it takes to succeed with a China joint venture, check out the following:

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

Though we often talk generally about what it takes to form a company in China, a reader recently pointed out to me that we have never set out the basic steps one must take to do so. The following sets out the basic steps a foreigner usually must take to form a Wholly Foreign Owned Entity (WFOE) in China. For more information on what is required to form a company 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.

 Forming a WFOE in China typically requires the following:

1. Make Sure Your Business is Legal For Foreigners. Determine if the proposed WFOE will conduct a business approved for foreign investment by the Chinese government. For example, until recently, China prohibited private entities from engaging in export trade. Be sure your business will be legal.

2. Provide The Proper Documentation. The investor in the WFOE must provide the documentation from its home country proving it is a duly formed and validly existing corporation or Limited Liability company, along with evidence showing who from the investor is authorized to execute documents on behalf of the investor. The investor also often must provide documentation demonstrating its financial adequacy in its home country. 

3. Investor Documents Needed. The Chinese government normally requires the following documents from the investing business entity:

  • Articles of Incorporation or equivalent (copy)
  • Business license, both national and local (if any) (copies)
  • Certificate of Status (original)(U.S. and Canada) or a notarized copy of the Corporate Register for the investor or similar document (original)(Civil Law jurisdictions)
  • Bank Letter attesting to the account status of the investor company (original).
  • Description of the investor’s business activities, together with added materials such as an annual report, brochures, website, etc. The first four of these must be in Chinese. The last one may be submitted in English, with a Chinese summary.

4. Consider Forming a Special Purpose Company to Own the WFOE. Many investors create special purpose companies to serve as the investor in China. China’s company regulators have become accustomed to this process. However, the Chinese regulators will often still seek to trace the ownership of the foreign investor back to a viable, operating business enterprise. It is common to form a Hong Kong company for this purpose and there are often tax benefits in doing so. 

5. Secure Chinese Government Approval. 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 company registration process. If the project is not approved, the company will not be registered. 

6. Compile and Provide These Documents for Chinese Government Approval. The following documents must usually be prepared and then submitted to the Chinese government:

  • Articles of Association. This document will set out all the details of management and capitalization of the company. All basic company and project issues must be determined in advance and incorporated in the Articles. This includes directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital.
  • Feasibility Study. The project 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 to draft up the feasibility study (in Chinese).
  • A Lease. An agreement for all required leases must be provided. This includes office space lease and warehouse/factory space lease. It is customary in China to pay rent one year in advance and this must be taken into into account in planning a budget because the governmental authorities will be expecting this.

7. Compile and Provide These Additional Documents for Chinese Government Approval. You will also usually be required to provide the following documents:

  • Proposed personnel salary and benefit budget. If the specific people who will work for the company have not yet been identified, one must specify the positions and proposed salaries/benefit package. Benefits for employees in China typically range from around 30% 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 (usually one year or more) during the start up phase of the Chinese company. These documents must be in Chinese.
  • Any other documentation required for the specific business proposed. The more complex the project, the more documentation that will be required.

8. The Approval Process. It usually takes two to five months for governmental approval, depending on the location of the project and its size and scope. Large cities like Shanghai tend to be slower than smaller cities. The investor must pay various incorporation fees, which fees vary depending on the location, the amount of registered capital and any special licenses required for the specific project. Typically, these fees equal a little over 1% of the initial capital. 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.

if you comply fully with the above, your chance of getting your WFOE approved is nearly 100%.

Yesterday, in a post entitled, “How to Start a Business in China — WFOE,” we discussed the basic requirements for forming a wholly foreign owned entity (WFOE or WOFE) in China. One of the questions we are most frequently asked about how to form a WFOE in China is is how much the Chinese government requires in minimum capital.  This post follows up on yesterday’s post by addressing the minimum capital requirements issue.

Every company in China must have a stated registered capital. This amount is provided in the Articles of Association of the company and is also noted on the company register. Beginning in 2006, this company register is available to the general public. 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. 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 operating the company. It need not 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 after the Chinese company begins normal business operations. This also is not true. Once the capital is contributed to the Chinese company, it can never be withdrawn for anything other than paying company expenses.

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 and a failure to abide by Chinese law all the way along the process will likely lead to an inability to get money out of China at some point down the road.

Under the new Chinese Company Law, the minimum capital requirement for multiple shareholder companies has been reduced to 30,000 RMB (less than $5,000 USD). For single shareholder companies, the amount is 100,000 RMB (around $13,000 USD). However, these numbers have no real meaning for the formation of a WFOE in China.

The real question is what the Chinese authorities will consider as adequate capitalization for the specific project. Of course, that answer varies by type of business and 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 area of China. It is expensive to operate a capital intensive business like manufacturing, but relatively inexpensive to operate a knowledge based consulting business.

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 and 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 an 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.

In determining what constitutes adequate capital, one needs to consider the peculiar situation in China that building rents are virtually always paid in advance, that payment for products for sale are virtually always paid in advance, and that a reasonable advance reserve for salaries is also required. Thus, the initial start up costs are much higher than in a location like the United States, where credit and time payments are more common. In addition, the foreign investor needs to take into account the risk aversion of the Chinese regulator. The Chinese regulator will not approve a project that looks risky or under-funded. The regulator has no incentive to do this, especially for a 100% foreign owned entity.

The government sometimes permits the minimum capital to be paid in installments over up to two years, though the first installment must be at least 15% of the total amount required and it also must be at least the statutory minimum for total capital. The capital contribution can be made in money, equipment, intellectual property, or other transferable property, but the monetary contribution must be at least 30% of the total capital amount. The government will appraise the value of any non-monetary contribution and our experience has been that it will come in fairly low in its valuation.

We frequently see two big mistakes being made by foreign investors when it comes to their putting in the required minimum capital. Foreign investors hear that assets can be used as a contribution towards the minimum capital requirement, so they go ahead and ship certain assets over to China, with the expectation of then using those assets towards minimum capital. The problem with this approach is that unless the proper authorities have been notified and granted their approval in advance of the shipping, the assets you just shipped to China will not be applied towards minimum capital, and you will have a huge problem on your hands.

The other common mistake we see is the foreign investor putting a value on its assets (including its intellectual property) and assuming the Chinese regulators will put the same value on those assets in determining the contribution towards minimum capital. The Chinese regulators will require their own appraisal (at your expense) l of anything other than monetary contributions towards the minimum capital requirement, and those appraisals tend to come in low, particularly for IP.