Establishing a Company

 

Wholly Foreign-Owned Enterprises (WFOE)

Background

The wholly foreign-owned enterprise (“WFOE”) has been the preferred investment vehicle for many years, in part because the foreign investor retains 100% equity, but also because the alternative, establishing a joint venture, requires negotiating with a Chinese partner, a process that can be long and complicated. The liability of the investor is limited to its registered capital.

The environment for establishing a WFOE improved in 2015, when minimum capital requirements and capital registration obligations were eliminated. Likewise, companies are now free to stipulate deadlines for contributing registered capital and the form in which these contributions are made, as well as the ratio of non-cash and cash contributions.

Financing

The three main forms of financing a WFOE are:

(a) Equity financing in the form of a contribution of the share capital or the retained earnings;
(b) Debt financing by the foreign shareholder in the form of a shareholder loan; and(c) Debt financing in the form of a bank loan with a local or international bank based in China.

As is the case for limited liability companies in most other jurisdictions, establishing a WFOE requires equity financing by the founding shareholder(s) in the form of share capital. In practice, the amount of the share capital is usually dependent on the (informal) equity requirements in particular industries and the planned business activities of the WFOE.

In addition to the share capital, Chinese law requires each foreign investor to determine the total investment amount (“TIA”), which represents the total financing amount that the shareholder intends to contribute to the WFOE. The TIA may be equal to or greater than the share capital and is subject to particular statutory ratio requirements, as shown below. The balance between share capital and TIA equals the amount of foreign capital debt granted to the WFOE. It is generally referred to as the maximum amount of the permitted loan (“borrowing gap”).

Total investment amount                    Share capital required

Up to USD 3m                                    At least 70%
More than USD 3m up to USD 10m     At least 50% (min. USD 2.1m)
More than USD 10m up to USD 30m   At least 40% (min. USD 5m)
More than USD 30m                          At least one third (min. USD 12m)

The “borrowing gap” may be financed with a shareholder loan, but the shareholder is not obliged to do so.

Share capital

The share capital must be provided by the shareholder. It can be contributed for the most part in the form of a cash contribution or contribution in-kind, including land use rights or intellectual property. As a matter of principle, in-kind contributions require a valuation report by a state-approved expert. 

Cash amounts due are paid by the WFOE shareholders to the WFOE’s capital account in China. 

Within the borrowing limits described above, a WFOE may be financed by a foreign currency loan, and this is often provided by the foreign parent company. Foreign currency loans must be registered with the State Administration of Foreign Exchange (“SAFE”).

Lastly, external financing in local or a foreign currency, which must be in the form of a local bank loan from a Chinese bank or a foreign bank in China, can complement the financing mix.

Establishment formalities

The most important documents necessary for establishing a WFOE are its articles of association, the appointment letter for the management (“board of directors” or “managing director”) and the supervisory board or supervisor, the lease agreement for industrial premises, a notarized and authenticated commercial register excerpt and a letter of recommendation from a bank. All documents must be prepared in Chinese. Foreign documents require a certified Chinese translation.

After the required documents are prepared, establishing a WFOE only takes a few weeks. 

An easier corporate renewal process now only requires a WFOE to submit an annual report that is published in the Enterprise Credit Information System of the Administration for Industry and Commerce.

We have successfully advised numerous investors on establishing WFOEs and handle documentation in either German/Chinese or English/Chinese.

Equity Joint Venture (EJV)

Clients who require closer cooperation with a Chinese partner can set up a Chinese joint venture.

The selection of the suitable Chinese partner is of great importance, which is why the potential partner has to be investigated in-depth (“partner due diligence”). We conduct  partner due diligence professionally and confidentially. 

Once you have chosen a partner, it is important to detail each party’s obligations in the joint venture contract. Most joint venture terms are 10-30 years, though a term of 50 years or more can be obtained under certain circumstances. The distribution of profits corresponds to the respective capital contributions.

Special rules govern the ratio between registered capital and total investment (registered capital plus debt), and this ratio varies based on the size of the total investment. Although there is no statutory minimum contribution to registered capital, local approval authorities may impose one, and this requirement varies based on locale.

Our experience with numerous joint venture projects allows us to work together with you to prepare contracts that protect your interests.

Contractual Joint Venture (CJV)

The CJV structure is more flexible than that of the EJV. It is possible, for example, to distribute profits in a way that does not reflect capital contributions. The CJV may be formed as either a partnership or, if certain requirements are met, a legal person, usually a Chinese limited liability company. 

In a CJV without legal person status, each partner is responsible for their own performance, liabilities and tax obligations. This form of a joint venture is mostly chosen for projects in areas such as construction or infrastructure.

This is a flexible corporate structure subject to a wide scope of negotiated terms.

Representative Office

Some companies prefer to make their first entry into the Chinese market via a representative office, which can serve as the local presence of a foreign company in China. 

However, a representative office is not permitted to conduct operative business. It is limited to indirect business activities (supporting contacts, collecting information, market research, marketing). 

A representative office does not have legal person status; the foreign parent company is fully liable for its activities. A representative office may only be opened by a foreign company that has already been in existence for at least 2 years, and not more than 4 representative offices are permitted. The registration is valid for one year.

A representative office constitutes a comparably economical, fast and simple option to become familiar with the Chinese market. However, the disadvantage is that it is not entitled to carry out direct business activities, but is limited to support tasks. Establishing a representative office usually takes less than 2 months.