- Guy Tal
- October 3, 2021
- 3:07 pm
- Added Value, China, distribution, Enter to China, Incoropration, JV
Behind the scenes - Incorporation in China Better Bigger Faster
The era of COVID-19, such an unknown situation until now, does not seem to disappear soon. A business venture has recently become complex affair. It requires prolonged isolation in the countries of destination and origin, careful and intensive preparations, a government invitation (PU). The multitude of tests required to fly do not contribute to the process – as a result, our reality has evolved.
The ability to promote new businesses or supervise existing businesses abroad requires creativity, composure, and flexible thinking.
There’s no doubt that, with a population of more than 1.4 billion, China presents a tremendous opportunity for businesses of all sizes to sell their products. Chinese consumers are open to creating new relationships with worldwide brands. Chinese consumers are getting wealthier fast. More and more Chinese citizens are entering into the middle-class category. So, Chinese consumers are not scared of high prices with their higher disposable incomes.
After answering the question of whether to enter China, here is the answer to how. In this article, we will present 3 main routes, setting up a joint venture (JV), the traditional way of selling through distribution, or a wholly foreign-owned enterprise (WFOE).
To define what is the right way to enter the Chinese market, first of all, we need to define what the goal is and for what entity. For each purpose there will be the difference right ways, this also applies to the entity’s nature. For the purpose of this article, we will examine a medium-sized company, whose goal is to expand sales in China.
Definitions:
- JV – A joint venture (JV) is a form of the foreign-invested enterprise (FIE) that is created through a partnership between foreign and Chinese investors/local partners, who together share the profits, losses, and management of the JV. The Joint Venture structure in China has several advantages such as access to land, distribution channels, business licenses, labor, networks, and Communist-party support.
- WFOE – A wholly foreign-owned enterprise (WFOE) is a common investment vehicle for mainland China-based business wherein foreign parties (individuals or corporate entities) can incorporate a foreign-owned limited liability company. The unique feature of a WFOE is that involvement of a mainland Chinese investor is not required, unlike most other investment vehicles (most notably, a Sino-foreign joint venture).
As always it is not possible to ignore the COVID-19 reflection, some background for entry in this period – JV. Since the outbreak of the pandemic, we have observed a new trend in China’s foreign incorporation compared to past practices.
The JV partners contribute different levels of investment, input, and assets or resources to the JV, which are contrary to the original agreement.
Generally, most foreign companies have been cautious in choosing the JV mode as their market-entry approach of choice due to prospective managerial complexity, different cultures and business approaches between the partners, and the high risk of IP leakage.
It also seems that foreign law firms recommend not to incorporate as a JV, the reason may lie in their local interest to keep the cashbox in the ‘house’, or from a really bad experience. In any case, these did not help the JV’s reputation.
However, in the volatile, uncertain, complex, and ambiguous world of today, the JV structure has become popular for start-ups and even to large multinational companies that abandoning the WFOE
For the foreign stakeholder, opting for a JV is a way to reduce their upfront investment, share costs, and minimize risks by working with a local partner who is familiar with the local market, local culture, local knowledge, and local policies and practices.
The most common reasons for the failures of JVs:
The JV partners contribute different levels of investment, input, and assets or resources to the JV, which are contrary to the original agreement.
- Different cultures, management styles, and business approaches result in poor understanding, cooperation, management, and integration in real business operations.
- The JV partners do not communicate clearly about their respective goals, expectations, and objectives when establishing the JV.
- The JV partners fail to design the deadlock, exit, and termination mechanism for cases where expectations are not met.
- The JV partners fail to discuss the future capital increase or fund-raising approaches for business development as this may impact the partners’ shareholding percentage in the JV.
- Misunderstandings due to cultural gaps, do not forget: The meaning of the word “maybe” in Chinese is “no”, if a Chinese person says “yes” then it can mean “maybe”, but if he says “no” – then he is not Chinese. Chinese culture is characterized by refined and indirect speech, which makes it difficult to get a definitive or clear answer.
WFOE:
A medium-sized company that aims to enter the Chinese market must have a local partner. But more than that, the company owes a local partner with the same interests. The nature of this mechanism completely eliminates the above rule.
One of the significant disadvantages is that the company bears all the expenses so that the starting point in this complex market is also very low. In any case, we will present some of the advantages (Which in our study case constitute disadvantages) of WFOE:
Independence can be formed without a Chinese partner.
A WFOE is independent, able to manage its own operations, funding, and business development. Without a parent, it does not need to share profits, strategies, or Intellectual Property.
- Can make profits in China. A WFOE can fully carry out business in China, in line with its agreed business scope. It can issue local currency invoices to domestic customers and make profits from its activities.
- Able to dividend funds overseas. Any operating profit made in China can be converted to foreign currency for transfer to an overseas parent company.
- Able to hire staff directly. A WFOE can manage its own human resources (without using an agency) and hire staff both locally and from overseas.
Distribution Agreement Main Features,
Company advantage:
- Least resources Gradual familiarity with the market.
- A local partner who is knowledgeable in the market.
- Most of the expenses are on the distributor.
- Do not deal with end customers.
Disadvantages for the company:
- Most decisions are made by the distributor.
- Dependence on the local distributor.
- In some cases, working with multiple distributors is complex.
Framing a distribution agreement in China is an ideal option –
A Distribution Agreement could be a good possible option for the foreign companies to gain upper hand and better control over their Chinese partner, by setting guidelines and implications in the distribution agreement. Conflict, in this case, does not lead to the liquidation of property, assets, and capital as can happen in JV. The possible disadvantage is the maintenance of common interest, in matters of price, quantities, liabilities and the manner of payment the common denominator varies – these can lead to the dissolution of the package. Choosing a partner as in any situation (but in China in particular) is the challenge and also the key to success.
The distribution agreement is distinct from an agency agreement and an introduction agreement to which different Chinese laws apply. A foreign company that is unwilling to entrust this level of responsibility to a Chinese agent may alternatively prefer to appoint its Chinese partner as a distributor in a specified region, either on an exclusive or non-exclusive basis.
The perfect solution – a combination
Familiarity with the Chinese market requires time, connections, and trust with key people. The way to win these will begin with a distribution agreement, in which the company invests a minimum of resources but is exposed to the local market, its culture, and the nature of its business. Once the company has achieved its goals and been exposed to the characteristics of the local market and culture it is time to set up a joint ventureAt this point, the goal of the joint venture could be to set up a factory in China for the purpose of reducing costs in sales to China and the rest of the world. Another advantage is expanding production to more products or even cheaper R&D centers with government support. A decision on how to incorporate is complex and highly dependent on the nature of the company and its business status. The various considerations in this article can shed light on the general disadvantages and advantages of the various incorporation structure that are important to consider.
