Business in China:
Modes of Entry
Dr. Stephane J. Grand
BACK TO THE BASICS
WHAT WE HAVE SEEN SO FAR
• Importance of personal relations in China and local
preference
• Problems with contracts
• Relative importance of power vs. authority
• Appearances vs. fact-based reality
• Do not take anything for granted, remember that
Chinese culture is different and just as real as western
cultures
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2
THE PROJECT
DEFINE WELL THE GOALS
• Importing into China
• Sourcing from China
• Taking advantage of production costs in China for
foreign markets
• Producing in China for the Chinese market
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THE SPECIFICITIES OF THE PRC FDI REGS
THE HURDLES
• Convertibility of the RMB, both for repatriation of dividends
and payments into China
• High import duties and taxes
• High capital investment
THE REGULATORY FRAMEWORK
• The Foreign Investment Catalog
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1. COMPANY SETUP
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5
CHINA’S FOREIGN INVESTMENT CATALOGUE
ENCOURAGED INDUSTRIES
“The most favored category”
 Subject to less strict administrative requirements
 Eligible for favorable tax treatment and other benefits
 Investment only requires its registration with the PRC
government
 Encouraged investments generally relates to:

New and/ or advanced technology to China

Projects increasing exports

Projects improving manpower efficiency

Projects conserving the resources

Projects protecting the environment
SJ GRAND Financial and Tax Advisory
CONFIDENTIAL
Examples of “Encouraged”
industries:
Water conservation
technology;
Intellectual property
services;
Mining;
Manufacturing;
Transportation;
Warehousing;
Sanitation, fitness, and
social welfare industries
Education, culture, art,
radio, film, and television
industries;
Foreign funded projects
that directly export all of
their products;
Vocational education and
training.
6
CHINA’S FOREIGN INVESTMENT CATALOGUE
PERMITTED INDUSTRIES
“The standard category”
 Investment approval is generally assumed to be granted
without a hitch
 No particular restrictions
 No favorable tax treatments and other benefits
 Investment requires its registration with the PRC
government
 Reasons for allowing investments under permitted
category and not under encouraged one:

Potential overcapacity

Concerns over “blind investments” in Chinese market
SJ GRAND Financial and Tax Advisory
CONFIDENTIAL
Examples of “Permitted”
activities:
Production of carbonated soft
drinks;
Construction and operation of
oil refineries- (Annual output of
eight million tonnes or less);
Franchise business,
Commission business;
Automobile wholesale, retail
and logistics;
Medical institutions –
(Investment here is limited to
equity joint ventures and
contractual joint ventures);
Financial leasing companies;
Distribution and importation of
books, newspapers and
journals;
Importation of audiovisual
products and e-journals;
Internet music services.
7
CHINA’S FOREIGN INVESTMENT CATALOGUE
RESTRICTED INDUSTRIES
“The category subject to high scrutiny”
 Subject to higher levels of scrutiny and stricter
administrative requirements
 Automatic approval of the investment cannot be assumed
 Reasons for investments being subject to restrictions:

Technology has already been imported into China

Industry is not conducive for healthy environment

Industry is prone to high energy consumption

Industries is highly regulated by the State or fall under
State central planning
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CONFIDENTIAL
Examples of “Restricted”
activities:
Certain agricultural, forestry,
animal husbandry and fisheries
Mining of precious metal and
certain ores
Certain manufacturing
(tobacco, certain textiles)
Electricity (adoption of low
capacity generator)
Certain telecommunications
Certain wholesale and retail
trade
Electricity, gas, and water
production
Banking and insurance
industries
Real estate in high end
property
Golf courses
Production and distribution of
radio and TV programming
8
CHINA’S FOREIGN INVESTMENT CATALOGUE
PROHIBITED INDUSTRIES
“The disbarred category”
 Foreign investment is not permitted
Examples of “Prohibited”
activities:
 Investment may be denied at the discretion of approval
authorities
Mining of radioactive
materials
Arms and ammunition
manufacturing
Air traffic control
Postal Services
Futures trading
Social research
Gambling
Pornography
Publication of books,
magazines, and newspaper
Construction and operation of
villas.
Breeding and growing of
precious, high quality breeds of
animals
 Reasons for investments being prohibited:

Endanger state security

Pollute the environment

Against public well-being

Occupy a large amount of farmland

Endanger the use of military resources

Use manufacturing techniques that are unique to China
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CONFIDENTIAL
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LIMITATIONS TO LIMITATIONS
BEING SMART ABOUT THINGS
• It is always possible to structure businesses
differently when needed, and have licenses held by
third parties;
• Some industries are only forbidden to foreign
businesses on paper:
• The Variable Interest Enterprise
• Law firms and their tax regimes
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COMPANY REGISTRATION IN CHINA
INITIAL PHASE IS CRITICAL
• Your business scope, structure and location will affect
registration procedures and required documentation,
minimum registered capital, tax and insurance
obligations, environmental and hygiene regulations;
• Early mistakes can be costly to correct.
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PREPARATION CHECK-LIST
BEFORE MAKING YOUR INVESTMENT

Define precise business scope and assess feasibility/regulatory requirements.

Analyze set up costs in detail.

Be cost-skeptical and approach income and growth estimates conservatively, planning for
several foreseeable results (Low/Med/High).

Develop company financing plans with and without the support of foreign & local loans.

Address main tax concerns and expenses in consultation with a tax professional: Business
Tax, Income Tax, Tariffs, VAT, and other local taxes.

Pay attention to suppliers’ hubs and distribution centers, client bases, export/import
logistics, regional and local tax rebates, and staff residence and employment options.

Inform yourself about China’s social welfare and insurance systems as many of these
charges are the responsibility of employers.

Have management team in place and start local recruitment.

Most importantly, brace yourself for unexpected events and obstacles.
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MOST COMMON FIE STRUCTURES
1. Representative Office ("RO")
2. Wholly Foreign-owned Enterprise ("WFOE")
3. Equity Joint Venture ("EJV")
4. Contractual Joint Venture ("CJV")
CONFIDENTIAL
13
DECIDING ON STRUCTURE
REPRESENTATIVE OFFICE
Least dynamic of available entities.
Legal status: No capacity under
Chinese law; head office liable for its
RO activities in China.
STRUCTURAL LIMITATIONS
•
Sources of fund: Exclusively from RO’s
head office.
•
Employment: Can NOT directly employ
Chinese employees; must be employed
via a registered human resources
agency.
•
•
•
•
•
S.J. GRAND
Research and market surveys
relating to the products/
services of the head office
Head office product/service
displays and promotional
activities
Liaison activities in connection
with product sales, the
provision of services, domestic
investment by head office
Cannot issue invoices (Fa Piao)
Cannot engage in profit
making activities
Cannot receive payment
Cannot sign contracts
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DECIDING ON STRUCTURE
WFOE
Most popular option
Legal status: Limited Liability Company
Sources of fund: Minimum registered
foreign capital requirements set
according to business scope and
location.
Employment: Can hire directly; staff
must be provided with contracts that
are duly prescribed under Chinese law
concerning matters of employment,
remuneration, dismissal, welfare
benefits etc.
S.J. GRAND
STRUCTURAL LIMITATIONS
ADVANTAGES
Independence;
no domestic
• • Research
and market
surveys
partner
required
relating to the products/
• services
Autonomous
legal entity
of the head
office
•
Able
to
take
advantage
of
• Head office product/service
industrylocation-based
displays
andand
promotional
tax exemptions and subsidies
activities
Greater
level ofinIPconnection
protection
• • Liaison
activities
• with
Canproduct
issue invoices
and receive
sales, the
revenueofinservices,
RMB
provision
domestic
investment by head office
• DISADVANTAGES
Cannot issue invoices (Fa Piao)
Lengthy
registration
•  Cannot
engage
in profitand
licensing
process
making
activities
Lack ofreceive
established
•  Cannot
payment
connections
of joint venture
• Cannot
sign contracts.
partner
15
Quick Comparison
RO
WFOE
Registration Procedures
Incorporation documents, bank
statements of credit
Business plan, name approval,
corporate documentation such as
Articles of Association
Time Required
1-2 months
3-5 months
Capitalization
No registered capital required
Minimum registered capital depending
on industry and locality; minimum
investment RMB 100,000
Business scope
Cannot engage in profit making
activities (except law firms)
Can engage in direct business
operations as listed in Articles of
Association
Liability
NOT legal person; liability assumed in
parent company
Legal person; limited liability company;
parent company liability limited to
WFOE registered capital
Regulatory Requirement
No MOFCOM approval for most
industries; registration with AIC
MOFCOM approval and registration
with AIC
Tax Method
Cost + or Actual method
Actual taxation method
Adaptability to demand
Cannot establish subsidiaries or
branches
Can establish subsidiaries or branches
Staff
Cannot employ directly; must use
registered employment agencies
Can employ directly
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DECIDING ON STRUCTURE
STRATEGIC ADVANTAGES
JOINT VENTURES
A joint venture is an entity formed by a foreign investor or a foreign individual with a
Chinese company, in which the foreign party owns more than 25% of shares
1.Equity Joint Venture (EJV)
Limited liability company; profits and losses are distributed between parties according to
the capital in proportion to their respective equity
Requires board of directors and contractually appointed management team
2. Contractual Joint Venture (CJV)
Can operate as limited liability company or as non-legal person; profits and losses
distributed according to provisions of CJV contract
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TYPICAL WFOE REGISTRATION PROCESS
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
Submit your name for pre-registration
Open a temporary account (optional)
Approval by relevant ministries for restricted activities
(education, law, medical and other fields)
Submit Articles of Association for approval
Approval by the Ministry of Commerce
Organization Code
Corporate Certificate of Approval by the Ministry of Commerce
Issuance of the Business License by SAIC
Capital injection
Capital verification report issued by CPA firms
Registration with Public Security Bureau
Production of company, finance and legal representative seals
Organization code certificate
Open basic RMB bank account
Tax Bureau Registration
Open Foreign Currency Capital Account
Foreign Exchange Registration
Tax Machine Setup
Statistics Registration Certificate
Finance Registration Certificate
Customs Registration Certificate (import/export companies)
Registration with social insurance institution.
S.J. GRAND
TIME:
12 weeks –
5 months
(longer for
some
industries)
18
WFOE FINANCING – REGISTERED CAPITAL
•
Funds should be transferred specifically to denominated Capital Account.
•
Payer's name must match exactly the investor on the Certificate of Approval
•
The capital injection(s) must follow the amount and periodicity indicated in the Articles
of Association. Based on Chinese regulations the amount should either be equal to the
full amount of the capital or at least 20% of total registered capital and be injected
within 90 days from the issuance date of the business license.
•
Bank fees should not be deducted from transferred capital but instead paid at the
remitter's level in China including the bank fees charged by the remitting and
intermediary bank(s);
•
Have sufficient funds available (to cover at least 2 months of operations) to avoid the
need for time consuming capital increases or unapproved shareholder loans.
•
The Capital Account can only be used for capital injection.
•
Actual injection amount and registered capital amount must match 100%
•
Capital transfer must be in the same currency as indicated in the Articles of Association
and the Certificate of Approval
•
Capital Denominated in RMB becoming possible
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SPECIFIC ACTIVITIES: IMPORT AND EXPORT
The largest businesses (foreign and Chinese) are certainly
importation of foreign goods into China and export of Chinese
production.
Purchasing from China has been made easy, but:
• Payment terms are rarely convenient when buying from a
Chinese factory,
• Quality control is a critical issue,
• Ethical issues subsist (child or prisoner labor, source of
some raw materials).
20
EXPORTING TO CHINA
An opaque regulatory environment, weak rule-of-law, and
intellectual property rights violations continue to challenge
export business.
Without proper knowledge and thorough research, entering
the China market may turn out to be a fairly complex, risky and
challenging process.
21
EXPORTING TO CHINA
For an exporter looking to enter China
market, it can be intimidating to know
exactly where to begin.
THINGS TO DO BEFORE EXPORTING TO CHINA
22
EXPORTING TO CHINA
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EXPORTING TO CHINA
PHASE 1
The best way to enter China’s market is
through a reputable or well-known agent
or distributor for the following main
reason:- Distributors are located regionally
and typically have larger sales
network.
- Distributors have better
understanding of China’s market so
they can provide assistance in
developing distribution strategies in
China.
PHASE 2
Establish a foreign invested
commercial enterprise “FICE”.
Finally, when the parent
company has acquired enough
knowledge and relationship in
China, it’s time to set up a
business.
An FICE can be used as an
appropriate investment
vehicle to set up export
business in China.
- Easy to set up distribution network
without having to deal with issues
related to distribution rights and
licensing.
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2. SPECIAL CASE: ACQUISITIONS
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ACQUIRING A CHINESE COMPANY
IS THIS REALLY WISE?
 Stepping into a Chinese company is a sure way to feel a real culture shock;
 What are you really buying? Production capacity? Distribution network?
Personal relations?;
 Why it might make sense to do an asset deal rather than a share deal;
 Always seek counsel;
 Always do legal, financial, operational and environmental due diligence work.
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DUE DILIGENCE
ACCOUNTANCY
 Analyze fixed assets: are they reflecting the reality of the company’s
operations? Assets may be overestimated or have inaccurate depreciation.
Ensure that the company is the true contractual owner of the fixed assets;
 Accounts receivables: confirmation with clients is essential in order to
double check the target company’s explanations of total billing. This process
should also apply extra scrutiny to a company’s aged receivables balance.
Where applicable, suppliers should also be verified;
 Cash position should be confirmed through a letter from the banks, and in
some cases sending it to the regional headquarters may be preferred;
 Check other payable and liabilities: analysis should be done on salaries,
social insurance payments or liabilities such as pension payments for former
employees; In some cases, higher salaries are negotiated in exchange for
underpaying social insurance obligations;
 Business expenses: check the authenticity of invoices.
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DUE DILIGENCE
TAX
 How does the PRC GAAP differ from the accounting standards normally
used by the investor? Do these issues have the potential to create confusion
about the overall financial position of the target investment?
 Do transfer pricing issues or exposure to transfer pricing apply to the
company in question?
 What are the applicable preferential tax rates based on the company’s
industry or operational scope, and what is the extent and time length of
these preferential rates?
 Is the company in compliance will all foreign exchange regulations?
 Is the company fulfilling its withholding tax responsibilities?
 If applicable, are all customs regulations being followed?
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DUE DILIGENCE
OPERATIONAL
 Experienced foreign investors and companies have been duped because
they did not conduct investigative operational due diligence.
 Reviewing financial statements and other company documents is unlikely to
provide all vital information for a potential investor, and is inadequate to
provide a complete picture of a company’s operations
 Unofficial site visits must be conducted to confirm “on paper“ activities.
 Independently verify volumes of sales or purchases from suppliers.
 Can you secure interviews with lower level staff or security guards at
factories or facilities? Sometimes interviewing lower level personnel who
have not been coached on what to say to investors can help in getting a
truer picture of the target in question.
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DUE DILIGENCE
LEGAL
 Have you confirmed your target has rights to its technology, trademarks and
patents?
 Does it have all necessary licenses and permits?
 Investigate ownership structure carefully. Are there any hidden owners or
partial shareholders?
 Investigate human resource management; confirm activities of all major
employees. Family members often “employed” to minimize tax.
 Confirm that the company in question owns the land use rights itself and
that these rights are not owned by third parties or parent/affiliate companies
of your target.
 Common problems include unenforceable informal arrangements between
companies and local officials, land improperly zoned for current use, or
mortgaged land and buildings detracting from the target company’s overall
value.
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DUE DILIGENCE
ENVIRONMENTAL
 Company’s holding of all appropriate environmental permits;
 Examining any potential outstanding liabilities or costs due to
environmental contamination or degradation;
 Ensuring land included as part of any deal is not contaminated (soil
sampling can determine this);
 Clarifying what environmental management systems a company has in
place;
 In the case of land containing factories, examining wastewater management
and waste disposal capabilities and procedures;
 Investigating any existing arrangements with a locality’s governing
environmental body.
31
POST-MERGER INTEGRATION
 The most difficult thing after an acquisition is to convince people that the
company has changed hands:
 Establish internal control procedures,
 Effect strong cultural changes with Chinese characteristics,
 Communicate well with suppliers and customers,
 Remove the former owners from management.
32
3. FINACING BUSINESSES IN CHINA
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THE PROBLEM WITH THE RMB
WE ARE STILL IN A COMMUNIST COUNTRY
 The currency is not freely convertible, which means that funds brought into
the country are more difficult to take out (procedure);
 Funding a company with loans:
 Cash pooling is exceedingly difficult because of business scope
limitations
 Local loans are exceedingly difficult to get;
 Thin capitalization rules impact intercompany loans in foreign
exchange.
34
THE PROBLEM WITH THE RMB
WE ARE STILL IN A COMMUNIST COUNTRY
 What is a thin capitalization rule:
 A rule that limits the amount of loans a company can get in proportion
to the paid-in capital.
 TCR in the PRC;
 Total investment equals registered capital plus borrowing gap:
 You contribute 100 worth of registered capital
 The formula gives you a total investment of 140
 The borrowing gap is 40
 TCR table:
Total investment
RC/TI
RC as % of TI
<= USD 3M
At least 7:10
70%
USD 3-10M
At least 1:2
50%
USD 10-30 M
At least 2:5
Higher of USD 5M or 40%
> USD 30M
At least 1:3
Higher of USD 12M or 33.3%
35
THE PROBLEM WITH THE RMB
WE ARE STILL IN A COMMUNIST COUNTRY
 The registered capital is fixed, and has to be legally increased in order
to bring in more capital.
 Each increase in registered capital can take from 30 days to forever.
 The increase in registered capital does not always mean a direct
increase in total investment.
 Some local authorities use a cumulative investment calculation
method
 Some others use a one-shot investment method
What does this mean?
Business planning is key: a clear evaluation of the financing needs
upfront is critical
36
“What Carrefour is doing right (in addition to grabbing and building as many
retail outlets as it can in the big cities) is simple: They're selling in a Chinese way
to Chinese consumers”
- Paul K. Ward, CRM Consultant, in 2005
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Two pioneers in the globalization of the retail industry
CARREFOUR
WALMART
French based
American based
First hypermarket opening in 1995
First hypermarket opening in 1996
By 2010, Carrefour was operating
157 stores
By 2010, Walmart was operating
178 stores
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China’s Economic History
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China’s Consumers
22% of the
world
population
The shopping experience in China has evolved
dramatically over the past decades.
Chinese consumers continue to place great importance
on the freshness and quality of ingredients.
43% of the total
population lives
in urban areas
On one hand, the primary retail establishments for fresh
food items in China are OPEN MARKETS (« wet
markets ») which represent a wide variety of products
and a social experience.
65 million
young urban
consumers
On the other, FOREIGN RETAIL CHAINS such as Walmart
(U.S), Carrefour (France) have open hypermarkets in
major Chinese cities. They provide low prices and one
stop shopping for food and general merchandise.
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Carrefour vs Walmart
CARREFOUR
WALMART
Chinese characters Carrefour represent 家乐福”
(Jia le fu), which means “family, happiness and
luck
ENTRY STRATEGY : Close relationship
with Shanghai government (Carrefour
entered China market with a local
partner, Shanghai Hualian Company)
Walmart’s Chinese name “沃尔玛” characters
that simply sounds like the Walmart with no
meaning in Chinese.
ENTRY STRATEGY : Walmart abided by
the central government’s plan. A dispute
with local government forced to invest in
Shenzhen instead of Shanghai.
LOCATIONS : location of stores in
crossroads in intercity business centers
or urban residential areas
LOCATIONS : location of stores in
suburbans, mostly in rural areas with
lower disposable income and that can
only be reached by cars.
PRICING: High low pricing strategy
PRICING: Everyday low prices strategy
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Carrefour vs Walmart
SHOPPING ENVIRONMENT :
Carrefour made longer shelving
for Chinese consumers who like
contrast and comparison and
imported products for their 40%
foreigner customers.
SHOPPING ENVIRONMENT : No
differentiations for Chinese
customers or customized
shelving. Walmart didn’t merge
with Chinese habits and tastes.
SUPPLY CHAIN : Carrefour relies
more on local distributors to
deliver direct to stores, to
increase flexibility
SUPPLY CHAIN : Walmart has a
40,000 square meter central
distribution center in Kengzian
(China).
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Carrefour vs Walmart
“ Global expansion will be a key avenue for retailers in developed markets to generate new
sources of revenue to offset slower sales growth at home....They [American firms] will be
late to the game, especially compared with large European retailers..”
-Retail Forward 2006
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Carrefour Success Story
Key Figures
25
Stores openings by year
€86,6 Total annual sales in Asia and €55,83 billion total
billion
annual sales in China.
77%
Represents sales in China among total Asia sales.
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Carrefour Success Story
Key dates
1989 First settlement of Carrefour in Taiwan, helping to get
into Chinese market.
of Carrefour in China. First group
1995 Settlement
which set up hypermarkets in the country.
was already operating 83 hypermarkets
2006 Carrefour
in 34 cities
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? Why such a success
 Carrefour settled in China with
the
SUPPORT
OF
THE
GOVERNMENT
and
made
agreements
with
local
authorities.
 Carrefour purchased high goods
volume from China which
permits to WIN FAVOUR
POLICIES from local government.
 Carrefour has a RETAILER
ADVANTAGE and based its
strategy on selling also through
small suppliers
 The group ADAPTED ITS RANGE
OF PRODUCTS to Chinese local
tastes and consumer habits
 The group first introduced the
CONCEPT OF HYPERMARKETS in
the country
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Business in China:
Modes of Entry
Q&A
Dr. Stephane J. Grand