Joint ventures are a commonly used company structure in China: many of the most well-known companies, such as McDonald's, Starbucks, and most recently the Chinese ride-sharing unicorn Didi Chuxing have all adopted a joint venture (JV) company structure in China.
For foreign investors, there are two distinct reasons that a company may choose to enter into a joint venture.
First, it allows foreign businesses to invest in an industry sector that is categorized as 'restricted' under China's Negative List.
Second, it can enable a foreign company to make use of the local know-how, sales channels, and distribution networks of a Chinese partner, which can assist with the initial operations as well as expansion of the company.
Amid a slowing Chinese economy and growing market competition, setting up a joint venture may be a strategic investment vehicle for market entry or expansion into China – one that allows investors to reduce their risks while gaining access to local networks and resources.
Businesses must familiarize themselves with the new Foreign Investment Law to ensure they are complying with the latest corporate establishment and due diligence regulations in China.
Starting a joint venture in China
A joint venture or JV is a limited liability company structure formed by two foreign investors or a foreign individual and a Chinese company.
Once formed, the JV becomes a new legal entity in which the liability of the shareholders is limited to the assets they brought to the business. This liability is then restricted to the JV and does not extend to the parent company.
Types of JVs before the new Foreign Investment Law comes into effect
- Equity Joint Venture (EJV): This is a limited liability company where profits and losses are distributed between parties in proportion to their respective equity interest.
- Cooperative Joint Venture (CJV): This is a JV structure that offers more flexibility for investors. It can operate as a limited liability company or as a non-legal entity. Further, unlike the EJV structure – profit, risk, and control are not divided in proportion to their equity interests. Instead, they can be negotiated within the contract agreement.
Structure of JV under the new Foreign Investment Law
Under the new Foreign Investment Law, which is set to come effect on January 1, 2020, the distinctions between the EJV and CJV structures will be abolished.
Article 42 of the new law will repeal the Law on Sino-foreign Equity Joint Ventures (EJV Law), and the Law on Sino-foreign Cooperative Joint Ventures (CJV Law).
Instead, foreign-invested enterprises in the form of a CJV or EJV will need to change their governing structure to a three-tier structure in accordance with the Company Law – establishing the board of shareholders, the board of directors, and manager.
Existing JV companies will have a five-year transitional period.
The Foreign Investment Law is set to change many of the structural requirements of JVs, such as the shareholding ratio, organization formation, and regulations surrounding the internal governance of joint ventures – although the exact details are yet to be released.
Finding the right partner in China
Before moving to incorporate a JV in China, the foreign investor needs to find one or more local partners.
It is important to conduct thorough due diligence on the intended JV partner.
While a large part of the due diligence is best left to trained professionals, there are a few elementary steps that investors can perform themselves:
- Checking the partner's business license and operation status: This can provide the investor with valuable information as to who is authorized to make certain decisions in the company, what its registered capital is, the duration of the business license, the address, etc.
- Checking the partner's land use rights: If the Chinese party is providing land, it is important to make sure it actually holds the title to that land and is valued correctly. Illegal land acquisition is a common problem in China, so foreign investors need to be particularly careful when the JV partner intends to inject land as its part of the JV contribution.
- Checking financial reports: It is important to ensure that the financial information in the company books is an accurate representation of the company's financial position as Chinese tax authorities often subject foreign enterprises to a higher level of scrutiny. If in doubt, one can engage a certified asset appraisal firm to conduct an asset appraisal report.
There are many opportunities that a successful JV can bring to a business. It can help foreign companies identify the right market, navigate often complex local regulations, monitor and safeguard intellectual property, and leverage local talent.
For businesses that wish to adopt a joint venture structure in China, there are several preliminary issues to consider, such as:
- Is your business an 'encouraged', 'permitted', 'restricted', or 'prohibited' industry for foreign investment? This will determine whether you can in fact create a JV, and the incentives available.
- What is your business scope? This will bring clarity to how your business scope can fit within the wider JV structure.
- What is in your "Articles of Association"? This refers to structural issues like the company board structure, profits repatriation, trade unions, M&A, and liquidation.
- What should be your registered capital and total investment (cash, "in kind," loan, etc.)? This is a very important consideration and will need to be managed according to your business model.
- If you are a manufacturing entity, what proportion of your production is for export and what proportion is for domestic sales? A critical issue with major tax and operational implications.
- What is your profit distribution and liability? This can complicate matters in JVs.
- What taxes will you need to pay? These are likely to include business tax, foreign enterprise income tax, VAT, withholding tax, individual income tax, and customs duty.
- Where should your company be located? This will depend on your specific business and industry needs. It is important to compare several options, including development zones, if applicable, as each will have different costs and benefits.
- What will the internal management structure look like? This includes asking who will be the leading party in the daily running of the business? Who will be in charge of sales or export sales? Another key consideration is establishing if it is necessary to allow one party to unilaterally increase the registered capital of the business that would dilute the shares of the other party.
- What are the intangible considerations of running a successful joint venture in China? It is important to consider the business culture, customs, and local government priorities of the place of business.
Businesses should seek professional advice to ensure that they have undergone the necessary due diligence checks and procedural requirements before entering a JV company formation, and that such a structure aligns with their broader company strategy. This will protect them from exposure to any unnecessary legal risks.
If you want to know more about how to prepare for and establish your own joint venture structure, please connect with your local advisor.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.