Thinking of Doing Business in China? Three Key Steps | Andrew Lee

For businesses and investors outside of China who seek to enter out markets, there are three preliminary considerations to bear in mind:

a)     What industry are you going to enter?

b)     What investment structure will you use?

c)     Where will you set up?

What industry are you going to enter?

The Chinese government divides all foreign investment into three categories based on the industry into which you are investing:  Encouraged, Restricted and Prohibited.

Encouraged investment gains benefits such as tax breaks, fast tracking of administrative procedures, higher likelihood of bank loans and lower interest rates and easier access to land and office space.  Examples of encouraged industries are clean energy and high technology R&D. The benefits of investing in this area go towards offsetting the higher risks and difficulties involved with these areas.

Restricted investment enjoys none of the benefits of encouraged industry and is subject to higher levels of scrutiny than encouraged investments. A Chinese partner (by way of a Joint Venture) is always required if you engage in a restricted industry. Most joint ventures in China are restricted investments. Examples of restricted industries are manufacturing, hotel management and insurance.

Prohibited investments are, as the name suggested, not allowed.  Military weapon design is an example of a prohibited industry.

The details for these categories can be found in the Chinese Government’s Official Catalogue for Guiding Foreign Investment in Industries.

Once you have selected the industry you are investing in, it is also worth checking what additional regulations, potential benefits and restrictions apply to that specific industry. For example, ‘seafood import export’ is a restricted industry requiring a joint venture and there are also rules on the amounts of various seafoods that can be imported into China from overseas.

What investment structure will you use?

The most common investment structure is the Joint Venture (“JV”). This involves a partnership between a Chinese party and a non-Chinese party. Each party contributes capital and resources toward the JV and a company is established to do business in China.  Frequently, the non-Chinese party contributes technology, business practices and overseas connections. The Chinese party contributes local channels and resources, market knowledge and human resources. Additionally, parties choose their financial capital contributions.

Joint Ventures come in two types: the Equity JV and the Contractual JV.  They are similar but have some important differences such as how parties contribute capital toward the JV; managerial control structure; and liability and profit sharing.

JVs are the most common vehicle for foreign investment. In my experience, Chinese regulations, laws and dispute resolution procedures are relatively well established for JVs as compared with  other forms of investment.

Another vehicle for foreign investment is the Wholly Owned Foreign Enterprise (WOFE). Its major advantage is that this vehicle requires no Chinese partner; control, intellectual property and management remain entirely within the foreign party’s hands. When I first set up my own company in China ten years ago, this is the vehicle I used. At that time, there were considerable advantages in being a WOFE because the government was trying to incentivise foreign investment and many of the advantages enjoyed by encouraged investments also applied to WOFEs, regardless of industry.  These days, however, many of the advantages of the WOFE no longer exist and it is frequently useful to have a Chinese partner. If I were starting today, I would choose a JV over a WOFE.

Other forms of investment include a representative office or an agency. These have much lower requirements and are easier to set up, but also are greatly restricted in what they can do inside China. If your purpose is to access the Chinese market and labour force, and sell to Chinese consumers, these are probably not the ideal vehicles. If your purpose is simply to become known in China and to channel consumers toward an entity outside of China, these could be appropriate.

Where will you set up?

“Tier 1” refers to the cities with the best infrastructure, standard of living and development level such as Beijing and Shanghai. Locating here has the ‘prestige’ factor and also means easy access to facilities like banks, hospitals, courts, law firms and the internet. They are also highly competitive with the most expensive land and highest wages.

After Tier 1 cities, the “eastern” cities are generally considered more advanced, meaning access to higher income customers and better infrastructure (transport networks, airports, government bureaus, internet facilities) but with higher costs.

In order to promote investment in the poorer “western” regions, the Chinese government has set up a Catalog of Priority Industries for Foreign Investment in the Central and Western Regions.  The latest version is dated 14 May 2013.  There are major benefits available, including tax breaks and easier administration, to companies that locate in these regions, though they differ depending on industry.  (Two examples of priority industries are Guangxi Province with ‘medical and aged care’ and Inner Mongolia with ‘agricultural and livestock technology and products’.)  It is worth noting, however, that the infrastructure disparity with the richer eastern regions can be extreme.  For example, some western regions have limited access to fresh water.

Working through these three questions is an excellent first step to determining how to succeed as you bring your business to China.