A presence in China is a must for international companies seeking global expansion, but entering and operating in the Chinese market is fraught with challenges. What are the main points to consider when establishing commercial operations in China? And how can parent company management control developments on the other side of the globe?
A comprehensive review by Arie Schreier, Originaly published @The Marker Magazine
While Western companies have been present in China for over 25 years now, many are not yet certain about the right way to establish operations in the country. The combination of a vast geographic area, ever changing and opaque regulation, a unique business culture, foreign language and aggressive domestic competition mean China remains a significant challenge for international firms.
Companies which already have commercial operations in China, or ones taking their first steps there, would be wise to learn from the experience accumulated so far, to help them prepare carefully and plan their penetration into the Chinese market to the last detail.
In general, establishing a legal entity in China before your entry strategy has been decided upon is not recommended. Should you register a company in China at all? What type of company should it be? Which is the best location to establish it? These are basic questions that need answering. From our experience, the lion’s share of business activity in the first few years can be carried out with third party service providers before establishing a local entity. Taking advantage of third-party help will also lower your upfront investment. In addition, you will be able to benefit from the experience of these service providers while accumulating your own experience and taking the time to make a well-considered decision on registering a company only after you have the full picture.
Management principles for a Chinese company
Establishing a “Wholly Foreign-Owned Enterprise” (WFOE) in China has become easier in recent years. As a result, many local agents are offering the WFOE set up process at a very low cost. Be aware that these agents are using a ready-made company template. They do not consider the specific needs and attributes of each company. Regrettably, opting for the wrong kind of company structure is likely to undermine the chances for success from day one. Many foreign companies are tempted by the low cost only to find themselves with a corporate structure that does not suit their business plan and needs in China.
Poor management of a company’s operations in China is usually evident in failures to provide information to the company management and lack of transparency. These failures might lead to unprofessional management, which at best does not comply with Chinese business regulations and at worst may bring the entire operation in China to a halt. There may also be legal ramifications for the management and shareholders of such poor business practice.
By comparison, proper establishment of a Chinese entity, in line with the regulations and sound governance, allows the overseas management to keep the pulse and maintain control over its subsidiary in China.
In a nutshell, these are the seven principles one must not compromise on when establishing and running a company in China:
- Registration and incorporation: Choose a highly experienced agent or lawyer to register and incorporate your Wholly Foreign-Owned Enterprise in China. Ask for references. Be very serious about every detail of the incorporation documents since these details may prove crucial in times of crisis or during any change you may want to implement (e.g. sale, investment, partnership, and more).
- The managerial infrastructure: Recruiting your first operations manager is a crucial task for the Company’s success in its first few years. It is important to find a knowledgeable and experienced manager that meets your requirements and to not settle for less. Selecting an inadequate manager will hinder business activity, delay market development and, in an extreme case, may cause irreparable damage.
- Presence and engagement: Many foreign companies entrust communication between their headquarters and the China branch through single contacts on either side. This puts an unreasonable burden on the manager in China and prevents information flow. Add to that the language and cultural differences, and you may find information exchange between headquarters and the Chinese branch is below the level required to move the business forward. For this reason, more people in the headquarters need to be involved in the management and oversight of the Chinese branch, including making regular visits to China to build a first hand overview of the significant challenges faced by the local manager.
- Financial management: If you are not present in China, appoint a trusted representative to safeguard your stamps and bank passwords. An reputable accountant who has experience with companies of your size would be the best choice because s/he will be able to manage your accounts while overseeing the operations on your behalf. Ensure you develop orderly financial work processes from the start with clear work instructions. Comprehensive and thorough audits of all accounting aspects are important, including billing, filing of tax returns, and monitoring VAT refunds and other credits.
- Human capital: Draft and implement orderly human capital processes supported by clear instructions. Make sure you investigate the references and backgrounds of the candidates for the local manager and staff. Also make sure you support, guide and train the local staff on a regular basis.
- Setting the work practices: Chinese law requires every company to develop a corporate rule book. Many companies ignore this requirement, just to find that if they reach the Labor Court for some reason, the judges take the rule book very seriously. Furthermore, simply writing the rule book is not enough. Your employees need to read it and confirm they have read it with their signature. Only then are they bound by the practices set out in the rule book, which is very important in the case you find yourself dealing with a Labor Court lawsuit.
- Control, oversight and supervision: Name an external professional to conduct periodical audits of the company’s books, and finance and HR work practices: the audits should include inventory checkups, invoices, cash balances, bank reconciliations, sales contracts, employment contracts, and more. We also highly recommend establishing supervision and control mechanisms for other aspects of the business: warehouses, production lines, suppliers and procurement procedures, comparison of salaries and employee recruitment practices. Hold unannounced audits of your Chinese management company. This will ensure your Chinese CEO or partner remains accountable to oversight.
An engaged consultant
In conclusion, the scope, complexity, dynamics and changing regulations in China require that no one has complete control over your business in the country. When choosing an expert consultant for the WFOE establishment process, pick one who will not only support the process as an observer, but who will also be actively involved in the process. Responsibility for several aspects of the operations, be they supervision or active management, would make your consultant more engaged and committed. An entity commissioned to manage part of the Chinese WFOE operations-be it finance, logistics, administration or human resources-would share your interests and function practically as your strategic partner.
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