Chapter 2

Setting Up Shop (I)

Obtaining a Business License and Choosing the Right Legal Form

“The difficult part is, when you are a small company, you can’t always do things in an official way or with the right legal structure. Sometimes, you need to move in and out of gray areas. It’s sometimes out of your control. If you are a big company, you’ve got backbone behind you; you’ve got finance, partners, and legal departments.”

Susan Heffernan (Australia), Founder and Managing Director, Soozar

Introduction

This chapter covers the first set of “initial steps” for foreign businesspeople setting up shop in China: seeking the right business license, and choosing the best legal structure and form for the company. Chapter 3 will cover two other critical aspects of a new venture: finding the money to finance it, and choosing the right partner.

Foreign entrepreneurs have basically two legal options: (1) to establish a company outside of China, and subsequently open a representative office there; or (2) to form a foreign invested enterprise. Foreigners as individuals are not permitted to set up a Chinese firm (except in the form of a joint venture), although some of our interviewees found creative ways to bypass this rule, with widely varying degrees of success. The option of forming a joint venture with a Chinese partner is covered in Chapter 3.

The chapter covers two main topics:

As this chapter deals mostly with legal matters, a word of caution is appropriate. Laws and regulations change very rapidly in China, and vary widely depending upon the industry, location, and size of a proposed venture. Readers should therefore consider the material included in this chapter only as providing an overview. We strongly recommend getting legal advice before deciding on what is best for your company.

Getting Help with Licensing

China’s regulations are often incomplete or vague, requiring that business operators work in the “gray zone” described in Chapter 1. The good news is that incoming foreign businesspeople need not try to find their way through that zone alone, as assistance across a broad spectrum is available in China. At one end are the highly professional international law offices, whose fees few of our startup interviewees could afford. Happily, many other options exist. Our entrepreneurs used creative alternatives such as hiring small-scale international or domestic consulting firms, or using street-smart domestic staffers (even before they had officially launched), or—cheapest of all—hitting the streets in search of free or low-cost advice available through chambers of commerce, embassies, and business associations.

Alternatives to expensive international law firms are: small-scale international or domestic consulting firms, street-smart Chinese employees, or free or low-cost advice from international chambers of commerce, embassies, and business associations.

Most of our entrepreneurs who set up their businesses in China in the last 10 years have simply hired a small-scale consulting firm to handle the application process. Now that China has been open to foreign investment since the mid-1980s, hundreds of such firms exist in all the major cities. American software businessman Eric Rongley describes his experience: “After we started to seek [a business license], it went pretty smoothly. You pay a couple thousand [U.S.] dollars to a consulting company and they do the work.... From the time we started the process until we got the business license, it wasn’t more than two months.”

When U.S. entrepreneur Mark Secchia and his partner hired a domestic consulting firm to set up Sherpa’s in 1999, he admits that his method for finding an agent wasn’t very scientific: “We looked in a Chinese newspaper for registration firms and hired the cheapest one.” Secchia admits that he and his partner were fortunate in choosing an honest, professional firm. “We were really more lucky than smart.”

The China offices of international chambers of commerce can also be a low-cost resource for startups. Korean businessman Chun In Kyu needed only one month to set up a representative office for Shanghai Asset after he contacted the China offices of the Korean Chamber of Commerce.

Australian retail display designer and manufacturer Susan Heffernan advises using a mix of international and domestic firms for legal advice and assistance with procedures, especially if you plan to open as a wholly foreign-owned enterprise, rather than adopt the simpler form of either a representative office or a domestic company (explained further below). “My advice is: don’t use all of your money on getting a foreign firm to do the whole [business licensing process], but you definitely do need a good legal advisor. Then you can use a local consulting company in conjunction with a foreign law firm.” In her own case, she paid an international law firm for advice, which she then implemented using a local consulting firm.

“I spent a couple of months looking for my first employee because I knew that person was going to be extremely important for my company.... I really needed to be able to trust that person...”

Eric Rongley (USA), Founder and CEO, Bleum

Finally, our interviewees—both entrepreneurs and consultants—stressed the importance of hiring competent local personnel to help with the initial navigation of the government bureaucracy you will encounter in establishing your company. American entrepreneur Steven Ganster tells of his own experience in establishing Technomic Asia in China: “One of the most valuable resources for me from the beginning was a 24-year-old Chinese woman who I could trust, who was dedicated and could get stuff done, and who was street smart. She started our rep office really quickly. With someone like that, you can get an FIE set up without spending US$15,000 at an international accounting firm. You need to have the local wherewithal.”

Software entrepreneur Eric Rongley agrees: “[In the beginning,] I spent a couple of months looking for my first employee because I knew that person was going to be extremely important for my company. They were going to get the business license, and it would be written in Chinese and I wouldn’t be able to read it. All of the startup information was going to be written in a language that I didn’t understand. I really needed to be able to trust that person, so I spent as much time as I needed to find someone who I really thought would stick it through.”

One encouraging message voiced by the China-business pioneers is that, while the regulations may be vague or confusing, the procedures are often not as complex as in developed nations. After 25 years of working in China, Belgian businessman Jan Borgonjon, who has operated InterChina Consulting since 1994, describes business regulations for starting a business in China today as “quite straightforward” and “not that complicated” compared to the situation in some European countries, though he concedes: “There are always some surprises in China.” The regulatory complexity of launching a China-based business does vary by business category, Borgonjon says, so that launching a consulting firm, for example, is “quite a clear-cut business,” while seeking approvals to launch a distribution enterprise is “necessarily more complex.”

The business activity you are permitted to carry out depends on the type of license you have. Make sure your license gives you sufficient scope to develop your business.

Choosing the Right Legal Form

One of the most important decisions an entrepreneur in China faces is the choice of legal category under which to establish his or her business venture. A business can take the form of a foreign company with a representative office in China, a foreign invested enterprise, or a domestic-owned enterprise (formed via a Chinese partner). Each category has different requirements and offers different benefits and drawbacks.

In this section, our entrepreneurs and consultants share their real-life assessments of the pros and cons of each of these common legal categories. As China’s business regulations change frequently, and will vary depending on industry type, size, and business scope, this section isn’t intended to serve as a road map detailing the best route for setting up a company. However, it does serve as a travel advisory, with our seasoned travelers (our 40 China-based foreign entrepreneurs) providing warnings of rough conditions and potential hazards along each possible path.

We will start with the safest, but also most restrictive, legal option for entrepreneurs in China: setting up an offshore company, and then simply “parachuting” into China to do business.

“In China, if you are registered as a coffee bar, if you want to sell tea in the coffee bar, you have to get special government approval. If you want to serve sandwiches, you have to apply for a special approval letter.… So, I discovered that I... can do nothing else but sell cappuccino, espresso, macchiato—and that’s it.”

Oto Petroski (Macedonia) Founder, Trading company

Legal Option #1: Offshore Company

When considering the possible legal categories for launching a China venture, the safest, lowest-risk (but also most restrictive) option is to set up an “offshore company” elsewhere, and then simply travel into China to conduct business. Among our interviewees, 14 had set up a company outside of China—mostly in tax havens such as the British Virgin Islands, and especially Hong Kong—but regularly visited the mainland on business. (Despite reverting to Chinese control in 1997, in legal terms, Hong Kong is still considered, in many ways, a separately governed location.)

To legally expand the business scope of your company, you will need to apply for a new license every time and prove you have more minimum capitalization.

Scotsman Jonathan Di Rollo, who launched Career Development China, a publishing and consulting business, as a Hong Kong “shell” company, lists the benefits of launching this way: “It’s cheap, fast, easy, and not in mainland China.” He explains further: “First, you can have your own company in two or three weeks. Second, it costs less—there is no fixed capital to invest, and no extensive paperwork.”

In fact, Di Rollo advises easing into setting up the offshore company. “My approach was to start a legal entity only if I had to. If you can earn money by working as a freelancer, or in a team with other people or companies first, do that. Watch your cash flow.” During his first eight months in China, Di Rollo worked as a freelancer hired project-by-project by market research companies. It was only when clients began requiring him to issue officially recognized invoices that he launched his own company. By then, he had secured a customer base and could launch with less risk, he says. “A friend, who is an experienced entrepreneur, told me that when you start your own business, you must have three things: contacts, capital, and confidence. I had contacts and capital already in place. When I finally got the third thing, that pushed me to start the business.”

Dutch businessman Nic Pannekeet also launched his company, CHC Business Development, in Hong Kong, mainly to reduce launch-time and minimize taxes. “It was easier for us to set up the company in Hong Kong than in mainland China,” he says. If you follow the rules, he adds, registering in Hong Kong is “no more difficult than setting up a company back in Holland.”

But while establishing a business in Hong Kong (or in another offshore jurisdiction, such as your home country or an investor-friendly place such as the Virgin Islands) is often straight-forward, this method has several limitations for China-based businesses. For one thing, offshore companies, by definition, have no legal structure in China. In consequence, the company cannot undertake business functions such as hiring Chinese employees. By law, hiring Chinese employees requires that your company at least establish a representative office within China. Even after taking this step, the offshore company cannot recruit directly, but must use one of the handful of officially sanctioned human resources companies in China that are authorized to serve as middlemen in hiring domestic employees. To avoid these hiring restrictions, some offshore companies hire domestic Chinese as contracted freelancers, rather than as employees.

China’s business regulations change frequently and vary widely depending on industry type, size, and business scope. Rules are often enforced differently across China, depending upon the interpretation of the local government.

Another restriction: offshore companies cannot freely carry out sales transactions with Chinese clients. This means that customers in China must go through the entire import process—customs goods’ examination and approval, payment of import tax, customs tax and import value added tax, and other formalities—for which the assistance of an import/export agent is normally necessary. Finally, payment must be made in a foreign currency, which causes additional administrative procedures.

China-based legal expert Lluis Sunyer explains that establishing an offshore company in order to invest in China is “not in line with how Chinese authorities want foreign companies to [operate in China], which is through a legal structure in the mainland.” When investors use the offshore method, the Chinese government loses out on the company’s enterprise income tax and employee income tax revenues. So, the government has taken regulatory steps to address this problem, Sunyer says, including passing the new Enterprise Income Tax Law in 2008. In order to encourage China-based companies to pay taxes, the law introduces to China the concept of “taxpayer’s fiscal residence”—which covers companies that have been established in a foreign jurisdiction, such as Hong Kong, but whose actual management organization is in mainland China.

Another hurdle for offshore companies operating in China are the visa restrictions, which often impact foreigners wishing to work in China. Foreign nationals entering the mainland to work for an offshore company will not be given “resident” visas, but must repeatedly apply for a short-term F-class “visitor’s” visa. Chinese law allows foreigners to visit and stay in China under an F-class visa if they are invited for the following reasons (according to the Chinese Embassy of the United States): “a visit, an investigation, a lecture, to do business, scientific-technological and culture exchanges, short-term advanced studies or internship for a period of no more than six months.” F-class visas are normally renewed every six months, but applicants can also apply for a 12- to 24-month visa.

“My approach was to start a legal entity only if I had to. If you can earn money by working as a freelancer, or in a team with other people or companies first, do that. Watch your cash flow.”

Jonathan Di Rollo (Scotland), Founder, Career Development China

To avoid the above restrictions, another popular option for foreign investors is to register a company offshore and open a representative office in China. Fourteen of our interviewees have taken this route.

Legal Option #2: Representative Office

Many of our interviewees took the route of establishing an offshore company, and then opening a representative office in China. According to the American Chamber of Commerce in Shanghai’s Orientation China Guidebook (2007), this is “the most common way to invest in China, as [representative offices] are fairly inexpensive to establish and do not require capitalization.”

Israeli national Aviel Zilber, who launched his business development and investment company, Sheng Enterprises, in Hong Kong in 2003 and then opened a representative office in the mainland, describes the process of setting up a “rep” office as follows: “The procedure requires much more bureaucracy than in the Western world, but it’s not that complicated.” For Zilber, establishing a rep office was a logical first step into the China market. After four years of operation, the company then began “moving to form a trading company” within China.

Launching an offshore company is often faster and cheaper than launching a China-based FIE. However, this option restricts your business operations.

The rep office option allows foreign businesspeople to reside in China (rather than constantly having to renew a “visitor’s” visa), and to hire domestic staff indirectly through one of a handful of government-designated third-party Chinese human resources agencies. However, rep offices in China (with some exceptions, such as law firms and accounting firms) are still restricted to conducting “non-profit activities”—meaning promotion work only, with all sales transactions still conducted offshore. Thus, this option brings international investors one step further into China, but still offers the safeguard of maintaining all financial transactions outside China.

Legal Option #3: Foreign Invested Enterprise

The ultimate goal of many longer-established or larger-scale foreign business operators in China is to set up a wholly foreign-owned enterprise (FIE) or foreign commercial enterprise. The FIE status ensures sole ownership of the company, sole decision-making power, and more control over business operations.

More than half (22) of our entrepreneurs set up an FIE after surviving their initial years of operation in China. In the past, many import/export companies, in particular, were established as an FIE in one of China’s Special Economic Zones (SEZs), where the legislation allowed tax breaks. However, the government is progressively phasing out these perks through the implementation of the new Corporate Income Tax Law (2008). Even so, foreign investors are encouraged to look into the many SEZs on offer—they include bonded zones, bonded logistic zones, export processing zones, special development zones, and special technologic development zones—as they still offer attractive terms.

Forming a representative office in China is one step forward in making a commitment to China. This option offers advantages over operating as an offshore firm.

Turkish businessman Onder Oztunali, who launched the building materials trading company Globe Stone Corp. in Xiamen’s SEZ in 2005, says: “Outside the SEZs, you still have many restrictions; it can be a big headache.” U.S. entrepreneur Jeffrey Bernstein agrees, describing the launch of Emerge Logistics as an FIE in Shanghai’s Waigaoqiao SEZ as “very straightforward.” He adds: “The only challenge for a non-seeded company is that you need a certain amount of capital—US$200,000 at that time [December 1999].”

Today, many foreign entrepreneurs are also establishing FIEs outside the special zones. In such cases, location decisions are best made based on good government relations as well as the standard business considerations.

In general, the choice to set up as an FIE in China gives a company autonomy, but also requires both more money and more hassle compared to the fourth option: operating as a domestic company. (See below for details on taking this option.) For instance, foreign-owned startups must have far greater capitalization—three to five times more, depending upon the sector and business scope—than domestic companies. Also, when they are up and running, foreign-owned businesses must pay higher taxes as well as other expenses.

Attorney Lluis Sunyer explains that, since the implementation of China’s Company Law in 2006, domestic firms must have a minimum capital investment of RMB30,000 (approximately US$4,300) for a limited liability company (LLC) with more than one shareholder, or RMB100,000 (US$14,300) for a one-person LLC, or RMB5 million (US$71,400) for a company limited by shares.

On paper, China’s new Company Law is also applicable to FIEs, but Sunyer explains that two caveats apply. First, in actual practice, the local-level government will often request FIEs to have a higher minimum capital investment, far beyond the minimum amount set in the Company Law. Second, in several specific sectors, regulations set higher capital requirements both for Chinese-invested enterprises and FIEs.

“I have to pay for an office which I don’t use. The government says, ‘You must rent this office or I won’t register your company.’ If you are a Chinese company, you can choose where you have your office. This is discrimination….”

Oto Petroski (Macedonia), Founder, Trading company

Oto Petroski is a case in point. When he launched his FIE trading company, the Chinese government first required a minimum capitalization of US$100,000 for a narrow-based business scope and US$2 million for a broad-based business scope. While the startup fees for a company such as Petroski’s might be lower today under the Company Law, he still expects to pay more than his domestic competitors.

In addition to setting-up costs, operating costs are often significantly higher for foreign-owned companies than for local companies. Petroski, who now owns both a domestic-owned and a foreign-owned company based in Shanghai, says his foreign-registered company is required to rent an address in an expensive “international class” office building—a site he doesn’t use. “For the foreign company, I have to pay for an office which I don’t use. The government says, ‘You must rent this office, or I won’t register your company.’ If you are a Chinese company, you can choose where you have your office. This is discrimination against the business rights of foreigners versus Chinese.”

Adding further to their costs of operation, in January 2008, many types of FIEs in China lost their preferential corporate tax rate when the new Enterprise Income Tax Law was implemented.

Problems With Foreign Partners

Although many of our interviewees were pleased with China’s new openness to investing as wholly foreign-owned enterprises, several also warned that forming a partnership with a fellow “foreigner” in China doesn’t guarantee success. Many of the same risks—and some new troubles as well—that are present among Chinese partners were also found among international ones.

One problem that is typical of foreign partners, and less problematic with Chinese partners, is that they often simply leave China. Danish entrepreneur Simon Lichtenberg tells of the havoc wreaked on his company when his first partner decided to marry a Chinese woman and move back to Denmark. “In our business, we were handling real estate, timber, and furniture. I was the timber guy and he [his Danish partner] was the real estate guy. But then, the real estate market went bad, and he left in 1999. He went back to Denmark to become a teacher.”

Forming an FIE will generally give you more control over your business than forming a rep office or JV. FIEs can also take advantage of the incentives offered by Special Economic Zones.

Another problem is simply that some foreign-to-foreign partnerships end in divorce. Swiss businessman Nicolas Musy describes how the first business venture he established in China ended in disaster. “In my first China company, formed with a Swiss partner, I was quite young and was the minority shareholder. My partner sold his shares to a new partner, and that new partner with the majority of the shares just kicked me out.”

One of our entrepreneurs tells of another such case. “I had a pretty horrible experience with my foreign partner. It’s a very sensitive issue for me.” The underlying problem, he says, was an imbalance of power between the partners; although his team originated the project and “did everything,” the other side had made more of the initial capital investment and thus held more power. “When you are small and your partner is big, you are at a severe disadvantage.” Because the partner had paid in more capital at the beginning, disputes arose when the company began turning a profit. “Despite the fact that we gave [the partner] a very high return, they were still upset that we were going to make 50% of the profit without a commensurate amount of capital investment.”

Relations between the two sides soured after the firm was established and the foreign partner no longer considered him as necessary. “It’s always a tough position to be in because, frankly, as an entrepreneur, once you’ve given your financial partner your technology, once you’ve built the business, once you’ve hired employees, once you’ve opened a shop, once you’ve got all the customers, you’re no good [to them] anymore; you’re useless. They [the partner] can do it themselves. You basically work yourself out of the job.”

Looking back, our entrepreneur says he should have drafted the initial agreement differently, clarifying the terms for his side of the partnership; but even that might not have helped, he concedes. “The only thing that can protect you is your initial business statement. If something happens, you can go to court; but if the partner has money and lawyers, the dispute could last for 10 years.”

Be wary of involving strong partners in your venture. Once they acquire the knowledge, technology, or contacts they seek from you, you may “work yourself out of a job”; Protect your interests legally from the start.

Our entrepreneur says the reason his firm was eventually forced out boils down to “the imperfection of the Chinese legal system.” He says, “There is no law firm that can give me any form of comfort. Chinese courts won’t favor the little guy against the financial institutions, who are playing many other games—banking games, insurance games—much more consequential than my little lawsuit. There is a technical term, the ‘bear hug.’ If a bear hugs you, eventually, you have to give up.”

One pleasant problem facing some startup FIEs is the flood of interest from potential foreign partners eager to link up with the China market. American entrepreneur Phillip Branham, who launched B & L Group, a construction project management and procurement company, in China in 2005, was quickly approached by many international businessmen seeking a cooperative arrangement. “I have met several entrepreneurs in the Middle East who wanted me to start businesses with them. I was invited to the home of an Iraqi in Dubai who, over a water pipe, really nice red wine and fabulous cigars, suggested that we start a business together. He wanted me to work in a construction company and help him to bring in Western techniques. The hesitation was on my part, because I wasn’t sure that I wanted to be involved. Where had his money come from?” Another invitation to cooperate, Branham says, would have meant entering an entirely new line of business: “Another gentleman wanted me to start a business with him selling parts from China in the Middle East—a supply distribution business.”

After less than a year spent building the business, Branham found himself facing more offers to cooperate than he could handle, and with some big decisions to make in terms of where the focus and direction of his new business should be.

Legal Option #4: Domestic-owned Enterprise

Although foreign nationals are not permitted to establish a Chinese firm, seven of our 40 interviewees chose to launch a domestic company, mainly in order to receive the benefits of a local business. This option allows the startup to enjoy significant benefits: lower taxes, lower operating costs, and fewer restrictions on hiring, location, and business scope. These foreign entrepreneurs established at least one of their China-based ventures as a domestic firm by registering the company in the name of their Chinese spouse, or a trusted Chinese partner. This method offers benefits but also carries risks (as several of our interviewees discovered), because all the legal rights are held by the Chinese partner alone.

U.S. businessman Phillip Branham is among those relying on their spouse (or spouse’s family) to serve as the Chinese partner or legal owner. Branham and his wife, Rebecca Li, had completed the process for B & L Group just before our interview. “I thought it would be terribly difficult to get a Chinese, business license, but actually each government district has an agency, and you pay them and they help you to get your license—done,” says Branham. “It’s a Chinese company; that’s the difference.” Branham says the main reasons for setting up as a Chinese company—through his wife’s brother and sister—were to save on time and startup fees. “I could actually form an FIE right now, but it would take about US$140,000 in capital. For the Chinese company, the required invested capital is very small,” he says. “We now have an FIE with a different work scope.”

Mexican entrepreneur Juan Martinez used both family and classmate connections to form an import/export company specializing in China–Mexico trade. His first company, formed in 2003 while he was still studying for his MBA at the China Europe International Business School in Shanghai, was set up as a joint venture with a Chinese MBA classmate, Snoopy Wen. As the business grew, the partners split the original company into two, amicably ending the partnership. Martinez went on to form Solis Holdings Import & Export (SOLHIX) through his wife Zhou Chunli, a Chinese national. Today, another Chinese MBA classmate, Winny Wu, and Martinez’s brother Fernando have also joined the company. After five years of operations, Martinez says working with family and friends is still the best option for his company: “I have started the businesses with family, friends and classmates—people I know. Sometimes, it can bring problems or difficulties, but so far, we’ve had good relationships with all the people.”

“I have started the businesses with family and friends and classmates—people I know. Sometimes, it can bring problems or difficulties, but so far, we’ve had good relationships with all the people.”

Juan Martinez (Mexico), Founder and Director, SOLHIX

Taiwanese businessman Michael Yang also chose to establish the Golden Atrium restaurant chain as a domestic company via a mainland Chinese friend, because that route was the most practical. “Ten years ago, when I started, China wasn’t very open. Government regulations for restaurants were very tight, both for foreign and local people,” Yang says. The local partner registered the business in return for a “management fee,” while Yang supplied the startup money and acts as manager.

Is Yang concerned about his lack of ownership rights? “My friend and I have a contract that specifies who owns the company and who has the rights to run the restaurants,” he says. If he and his partner ever have a dispute about ownership, Yang believes the contract would hold up in court. “I wouldn’t lose the case, so I don’t worry about it.” (Several other interviewees have experienced serious difficulties with local partners, as described in the next chapter.)

In founding Sherpa’s, Mark Secchia also initially used Chinese friends as domestic partners. Sherpa’s hired an agent to serve as its Chinese partner. This partner holds the legal ownership rights to the company but is generally not involved in the company’s day-to-day operations.

Secchia says that working through his Chinese partners has proven helpful, especially initially, because they have helped to guide him in the China market. “For example, when we first named the company, I wanted to insist on a particular name, but Steven said, ‘Stop and think about it for one day.’ The next day, when I woke up, I realized that I had chosen a stupid name.”

A frequently used option for forming a domestic company, and avoiding the higher fees often charged to an FIE, is via a Chinese partner: a trusted friend, classmate, or—most often—the spouse.

For the past eight years, Secchia has worked as CEO of Sherpa’s (now a business with turnover of between RMB3.5 and 4 million [US$500,000–570,000] a month) and the Chinese partners have stayed on the sidelines, meeting only socially. “The more active partner and I meet a lot. I’m his son’s godfather. He works in another company in Shanghai,” says Secchia. “We play tennis together and we talk about our work, but we don’t talk about the work details. He’s not allowed to work in the company. No company has two CEOs; it doesn’t work that way. Very few people in the company know him.”

“Maybe 15 years after the WTO accession, it will be easier for foreigners [to launch businesses in China] as FIEs. But right now, it’s a great advantage to be a Chinese company—a great advantage.”

Mark Secchia (USA), Founder, Sherpa’s

What about the risk, especially since the Chinese partners are not tied to Secchia by family? “It’s not fun to do so, but you have to think about [the possibility of] splitting the relationship. We were friends, but we formed an agreement because we knew a split could happen,” he says. One safeguard against a bitter breakup, Secchia explains, is that when the company was formed, he put all the debt into the company, not into assets. “If my Chinese partner wants to take the business, he would have to pay off a couple of million Renminbi. That’s one way to prevent it from happening.” Another incentive for the Chinese partner to continue cooperating is that, because Secchia serves as the hands-on CEO, he oversees the day-to-day banking operations and ensures that all of the company’s suppliers are paid on time. “If I take all the money and leave, [my Chinese partner] is going to be legally responsible for millions of Renminbi to pay out to suppliers.... My Chinese partner runs more risk than I do.”

The bottom line, for Secchia, is that the benefits of operating as a Chinese-owned company—including lower capital investment and less initial hassle, but also lower taxes and more freedom in terms of business scope—outweigh the risks. He believes that, while the situation may change in the future, establishing a business as a Chinese company is currently the best route for small companies and entrepreneurs. “Maybe 15 years after the WTO accession, it will be easier for foreigners [to launch businesses in China] as FIEs. But right now, it’s a great advantage to be a Chinese company—a great advantage.”

You can combine the advantages of each legal form. Launch a domestic firm to do business with Chinese clients, and an offshore firm to work with international ones.

One message voiced by many of our interviewees is that, although China has liberalized its markets (especially since joining the WTO in 2001), foreign investors are not guaranteed easy entry into the China market, especially if they seek to launch an FIE. Consider the case of Parisian fashion executive Valerie Touya, who launched a fashion distribution company in Shanghai in 2004. She went on to open a chain of designer clothing boutiques in Suzhou and Shanghai in 2006, two years after China officially opened its markets to foreign retailers. (Under WTO regulations, China opened its retail market to international investors in December 2004.) But since China’s opening to retailers, shop licenses have been given out sparingly.

Thus, by the time Touya was preparing to launch her business, she was aware that only a few of the giant international clothing retailers, including Zara and H&M, had been awarded licenses in China. Furthermore, the capital investment required to set up an FIE—RMB1.6 million (approximately US$230,000)—was beyond her means. “Even the chambers of commerce told me it would be better to set up under a Chinese name, rather than as an FIE,” she says. (For a more detailed assessment of China following its accession to the WTO, see the box “Investing in Post-WTO China” in Chapter 1.)

Prepare in advance the necessary legal documents to protect you in case something goes wrong with your Chinese partner. Get advice from a China-savvy lawyer.

Touya therefore chose to form her company through a Chinese partner. “By working through the Chinese friend, approval took only one month. Only through Chinese people is this possible.” After the business began growing, Touya discovered several drawbacks. First, when the retail stores became successful in Shanghai and Suzhou, she was approached by a businessman who wanted to cooperate with her in expanding the chain to Beijing. Touya had to turn down the opportunity so as not to overburden the Chinese partner with additional risk. “I felt that, if there was a problem, [the Chinese partner] would be held responsible, so I couldn’t grow too fast.” Then, after four years of successful operation, Touya decided to sell her company and move back to France. Again, because she wasn’t the legal owner, the sales process became complicated. Touya’s advice to incoming entrepreneurs is that, while setting up an FIE requires greater time and expense, it also allows for greater freedom—and financial reward—if the venture takes off.

Some of our other entrepreneurs have had far worse experiences with their domestic partners (see Chapter 3).

Conclusion

Choosing the business license category—offshore, representative office, FIE, or Chinese firm—is one of the key steps in correctly starting a new venture in China. Choosing the wrong legal method, or choosing one with limited scope, can hinder your growth. Our 40 China-based international entrepreneurs recommend using a small consultancy firm, or hiring a street-smart staff member, to help with the initial process of determining the ideal legal category and applying for a license.

SUMMARY OF TIPS

SETTING UP SHOP (I)