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Forms of Incorporation

There are two major forms of incorporating your business enterprise in the People's Republic of China. They are:

• Wholly Foreign Enterprise(WFOE or WOFE)

• Joint Venture(JV), which can be established in a variety of ways.

The Chinese government prefers the enterprise be established as a Joint Venture with a local Chinese partner. Rules, regulations and access to the domestic market clearly favor this method.

A WOFE is an enterprise in China which is 100% owned by a foreign company or companies. Establishment as a WOFE allows the foreign firm to retain complete control and direction of the operation. It also tends to maximize return as a second party investor is not involved. But, a WOFE can be more difficult at startup as the foreign firm may have no expertise in operating in China and little knowledge of the local area.

WOFEs are generally established as manufacturing or assembly operation for the purposes of export. WOFEs in China enjoy the benefit of low cost labor. A WOFE is not allowed to sell it's products into the Domestic market. WOFEs that sell into the domestic market use creative importation methods or export and re-import. Under either of these methods significant additional costs are incurred either as payments to a third party or in sizable duty rates.

WOFEs are often but not always, located in a Special Economic Zone(SEZ) where they can take advantage of special tax rates, improved infrastructure, and a variety of local suppliers and services which have grown in and around the zone in support of the SEZ.

Joint Ventures are businesses where a foreign firm takes on a local Chinese partner. The ownership usually is 51%-49% with the foreign firm owning the majority. This is no hard and fast rule and various different proportions can be established depending upon the desires of the two parties.

Foreign companies often enter into JVs for a number of reasons. The most common reason is to gain access to the domestic market. Without forming a JV, foreign firms find it all but impossible to gain market access. A Chinese national has, by nature, the rights to sell domestically and without incurring duties or other charges. As long as the business is profitable and sales in China are incremental, JVs can be an excellent choice. Certainly, when faced with the option of no access to the domestic market, it becomes the only choice.

A second major reason for entering into a JV is to utilize the knowledge and expertise of the local partner in doing business in China and the local area. This is especially true if it is the first endeavor into China for the foreign company. The local partner can be extremely valuable in expediting the startup of the business, gaining government approvals, lining up local services and suppliers or domestic distribution channels. They can also help to teach the foreign nationals how to do business in China, covering everything from rules and regulations to personal issues such as how to obtain expat housing and other needs.

The disadvantage to a JV is that another partner shares in the profits of the business. If this is incremental business, then it can be good for both parties. If the business is strictly export, one must question why enter into a JV and share the profits as low cost labor can be obtained in any one of a number of countries in Asia or even Latin America. (Do not forget availability of infrastructure in this equation) Along with the sharing of profits, however, comes the sharing of the investment risk as the local partner contributes funds or assets into the enterprise. Sometimes the contract assures the local partner a return on investment, mitigating business risk to him.

Joint Ventures can take a variety of shapes in term of ownership, contributions, participation and involvement of the partners. They can be 50-50 or 90-10. The local partner may be asked to be participative in running the day to day operations or he may be a silent partner who was acquired by the foreign firm simply to gain domestic market access. In some cases, the partner may be provided guaranteed return on investment regardless of the profitability of the JV. This allows the foreign firm more control over the direction and investment options of the JV.

The two partners will enter extensive negotiations prior to business startup to work out the details of the JV. Successful conclusion of the negotiations results in a workable JV which benefits he needs and wants of both parties. For more, see Negotiations.