Establishing a Presence in China Establishing a Presence in China for Marketing and Other for Marketing and Other

Business Purposes: Business Purposes: Joint Ventures versus Going It Joint Ventures versus Going It

AloneAlone

Green Trade Network SummitGreen Trade Network SummitMonterey Bay International Monterey Bay International

Trade AssociationTrade AssociationSeptember 19, 2008September 19, 2008

Martin Lewin, KALIK LEWIN

What is a Joint Venture?What is a Joint Venture?

• Typically in a Joint Venture the participants Typically in a Joint Venture the participants

contribute assets and share risks.contribute assets and share risks.

• Often the Parties create a separate legal Often the Parties create a separate legal entity for the commercial enterprise.entity for the commercial enterprise.

• A Joint Venture can be a partnership, a A Joint Venture can be a partnership, a corporation, or some other limited liability corporation, or some other limited liability company, depending upon tax, liability and company, depending upon tax, liability and other considerations.other considerations.

A Joint Venture is a generic term A Joint Venture is a generic term loosely referring to any association loosely referring to any association

of persons or companies jointly of persons or companies jointly undertaking some commercial undertaking some commercial

enterpriseenterprise

Do you need to Do you need to enter into a Joint enter into a Joint

Venture to do Venture to do Business in China?Business in China?

There are three legal structures There are three legal structures available in China under which available in China under which foreign companies can conduct most foreign companies can conduct most kinds of business:kinds of business:

•Equity Joint VenturesEquity Joint Ventures•Cooperative (Contractual) Joint Cooperative (Contractual) Joint

VenturesVentures•Wholly Foreign-Owned EntitiesWholly Foreign-Owned Entities

In addition, foreign companies can In addition, foreign companies can conduct limited business operations (i.e., conduct limited business operations (i.e., market research but not sales) through a market research but not sales) through a Representative office.Representative office.

•Profit and risk sharing are proportionate to the equity of each partner in the joint venture, except in cases of a breach of the joint venture contract.

•A minimum of 25% of the capital must be contributed by the foreign partner(s).

•There is no minimum investment for the Chinese partner(s).

•Share holdings in a joint venture are usually non-negotiable and cannot be transferred without approval from the Chinese government.

•Either party can hold the position as chairman of the board of directors.

•Equity can include cash, buildings, equipment, materials, intellectual property rights, and land-use rights but cannot include labor.

Key elements of Equity Joint Key elements of Equity Joint Ventures:Ventures:

•Parties involved may operate as separate legal entities and bear liabilities independently or may be registered as a limited liability entity resembling an equity joint venture in operation, structure, and status.

•No minimum foreign contribution is required.

•Contributions are not required to be expressed in a monetary value and can include labor, resources, and services.

•Profits are divided according to the terms of the cooperative venture contract rather than by investment share

•The foreign investor is permitted to withdraw all or part of its registered capital during the duration of the cooperative venture contract.

•Trade unions must be allowed to represent the employees in employment matters .

Key elements of Cooperative Joint Key elements of Cooperative Joint Ventures:Ventures:

•Registered capital must be subscribed and contributed solely by foreign investor(s).

•Business scope must be defined.

•WFOE can only conduct business within its approved business scope.

•Amendments to the business scope require further application and approval.

Key elements of Wholly Foreign Owned Key elements of Wholly Foreign Owned Enterprises:Enterprises:

Chinese authorities encourage Joint Chinese authorities encourage Joint Ventures in order to obtain Ventures in order to obtain

exposure to advanced technology exposure to advanced technology and new management skills.and new management skills.

However, Joint Ventures are However, Joint Ventures are not not requiredrequired for for

foreign company participation in foreign company participation in most industry sectorsmost industry sectors

When can a When can a foreign company foreign company conduct business conduct business

as a WFOE?as a WFOE?

Basic information on the requirements for foreign Basic information on the requirements for foreign investment can be found in “the Catalogue for the investment can be found in “the Catalogue for the Guidance of Foreign Investment Industries” published by Guidance of Foreign Investment Industries” published by China’s State Development and Reform Commission.China’s State Development and Reform Commission.

• The Catalogue classifies industrial sectors as "encouraged," The Catalogue classifies industrial sectors as "encouraged," "restricted" or "prohibited" "restricted" or "prohibited"

• Category coverage is comprehensive and precise, including 351 Category coverage is comprehensive and precise, including 351 encouraged industry sectors, 87 restricted industry sectors, and 40 encouraged industry sectors, 87 restricted industry sectors, and 40 prohibited industry sectorsprohibited industry sectors

• Industries not specifically identified fall by default under the Industries not specifically identified fall by default under the "permitted" category. "permitted" category.

• If a particular project falls under the "encouraged", "permitted" or If a particular project falls under the "encouraged", "permitted" or "restricted" category, foreign investors can invest in a project as long "restricted" category, foreign investors can invest in a project as long as the appropriate level of government approval can be obtained and as the appropriate level of government approval can be obtained and the investment complies with applicable restrictions on foreign the investment complies with applicable restrictions on foreign ownership. ownership.

• Direct foreign investment is not allowed in projects classified as Direct foreign investment is not allowed in projects classified as "prohibited"."prohibited".

WFOEs are allowed in almost all encouraged WFOEs are allowed in almost all encouraged and restricted and restricted

industry sectors listed in the Catalogue.industry sectors listed in the Catalogue.

Key exceptions include: Key exceptions include:

• Development and application of new technologies that Development and application of new technologies that can increase the recovery factor of crude oil (limited to can increase the recovery factor of crude oil (limited to equity joint ventures or contractual joint ventures) equity joint ventures or contractual joint ventures)

• Production as well as research and development of Production as well as research and development of certain automobile electronic devices, including, among certain automobile electronic devices, including, among others, power cell (NiH and Li-con) and control systems others, power cell (NiH and Li-con) and control systems (limited to equity joint ventures); (limited to equity joint ventures);

WFOEs are allowed in almost all encouraged WFOEs are allowed in almost all encouraged and restricted and restricted

industry sectors listed in the Catalogue. industry sectors listed in the Catalogue. (Con’t)(Con’t)

Key exceptions include: Key exceptions include:

• Power transmitting and transforming equipment (limited to Power transmitting and transforming equipment (limited to equity joint ventures and cooperative joint ventures): non-equity joint ventures and cooperative joint ventures): non-brilliant form transformer, high voltage implement great brilliant form transformer, high voltage implement great bushing, high voltage on-off operation implement, and freedom bushing, high voltage on-off operation implement, and freedom integer arc contact, direct current transmit electricity dried integer arc contact, direct current transmit electricity dried reactor, 6 inch direct current convertor clique high-power grain-reactor, 6 inch direct current convertor clique high-power grain-valve tube, electrical apparatus contact material, and non-Pb, valve tube, electrical apparatus contact material, and non-Pb, non-Cd solder accorded with EU command of RoHSnon-Cd solder accorded with EU command of RoHS

• Manufacture of the equipment of new energy electricity-power Manufacture of the equipment of new energy electricity-power (limited to equity joint ventures and cooperative joint ventures): (limited to equity joint ventures and cooperative joint ventures): photovoltaic power , geothermal power generation, tidal power photovoltaic power , geothermal power generation, tidal power generation, wave power generation, rubbish power generation, generation, wave power generation, rubbish power generation, methane power generation, wind power generation over 1.5Mmethane power generation, wind power generation over 1.5M

Wholly Foreign Owned Enterprises Wholly Foreign Owned Enterprises areare authorized to invest in:authorized to invest in:

• Construction and operation of electricity power by employing the Construction and operation of electricity power by employing the clean fuel technology of integral gasification combined circulation clean fuel technology of integral gasification combined circulation (IGCC), circulating fluidized bed more than 0.3 million kw, (IGCC), circulating fluidized bed more than 0.3 million kw, Pressurized Fluidized Bed Combustion Combined Cycle(PFBC) Pressurized Fluidized Bed Combustion Combined Cycle(PFBC) more than 0.1 million kw.more than 0.1 million kw.

• Construction and management of hydropower stations with the Construction and management of hydropower stations with the main purpose of power generating.main purpose of power generating.

• Construction and management of new energy power plants (solar Construction and management of new energy power plants (solar energy, wind energy, magnetic energy, geothermal energy, tide energy, wind energy, magnetic energy, geothermal energy, tide energy and biological mass energy, etc.).energy and biological mass energy, etc.).

• Utilization of sea water (direct use of sea water, seawater Utilization of sea water (direct use of sea water, seawater desaltation), using industrialization to recycle industrial sewage.desaltation), using industrialization to recycle industrial sewage.

(Continued on next slide)(Continued on next slide)

•Construction and operation of urban water-Construction and operation of urban water-supply plant.supply plant.

•Technology for recycling and comprehensive Technology for recycling and comprehensive utilization of resource, development and utilization of resource, development and application of the recycling technology of the application of the recycling technology of the waste dispelled by enterprises.waste dispelled by enterprises.

•Technology for environment pollution treatment Technology for environment pollution treatment and monitoring.and monitoring.

Wholly Foreign Owned Enterprises Wholly Foreign Owned Enterprises areare authorized to invest in (Con’t):authorized to invest in (Con’t):

Joint Ventures versus Joint Ventures versus Wholly Foreign Owned Wholly Foreign Owned Entities: Which Way Entities: Which Way

to Go?to Go?

There are advantages to establishing a There are advantages to establishing a presence in presence in

China through a Joint Venture.China through a Joint Venture.

• Overcoming a lack of familiarity with China’s Overcoming a lack of familiarity with China’s business and legal environment.business and legal environment.

• Gaining access to the JV partner’s knowledge base.Gaining access to the JV partner’s knowledge base.

• Lowering capital costs.Lowering capital costs.

• Addressing human resource issues.Addressing human resource issues.

• Gaining local community and government support.Gaining local community and government support.

There are significant potential There are significant potential downsides as well.downsides as well.

• Significant time and resources are needed set up a joint venture Significant time and resources are needed set up a joint venture and to oversee it.and to oversee it.

• Local partner’s objectives may be different than the foreign Local partner’s objectives may be different than the foreign company’s. company’s.

• Cultural differences may lead to misunderstandings and Cultural differences may lead to misunderstandings and operational conflicts.operational conflicts.

• Potential loss of control over day-to-day operations.Potential loss of control over day-to-day operations.

• Local partners have many ways to profit personally without the Local partners have many ways to profit personally without the Joint Venture itself making any profit. Joint Venture itself making any profit. 

• Foreign company may lose control over intellectual property.Foreign company may lose control over intellectual property.

A Study in the 2004 Harvard Business Review A Study in the 2004 Harvard Business Review reported that 48% of nearly 1,600 international reported that 48% of nearly 1,600 international joint ventures ended in failure in less than two joint ventures ended in failure in less than two years’ time.years’ time.

Advantages of a WFOE:Advantages of a WFOE:

• Autonomy and independence to carry out Autonomy and independence to carry out strategies without having to consult their strategies without having to consult their Chinese partners Chinese partners

• Operations and management efficiencyOperations and management efficiency

• Full control over management and profit Full control over management and profit distribution distribution

• Safeguard Intellectual PropertySafeguard Intellectual Property

As a general rule, choose the simplest structure As a general rule, choose the simplest structure that accomplishes the company’s objectives.that accomplishes the company’s objectives.

Even where collaboration with Chinese partners Even where collaboration with Chinese partners is needed, consider accomplishing this by is needed, consider accomplishing this by long-term contracts: Purchase/sale; licensing; long-term contracts: Purchase/sale; licensing; distribution, etc. distribution, etc.

Think of Joint Ventures as a last option, except Think of Joint Ventures as a last option, except where both the foreign company and Chinese where both the foreign company and Chinese partner will be contributing substantial assets partner will be contributing substantial assets (e.g., technology, land, buildings, equipment), (e.g., technology, land, buildings, equipment), long-term planning and long-term planning and operations are required, and objectives and operations are required, and objectives and operational modalities are clearly understood operational modalities are clearly understood and agreed upon. and agreed upon.

Maximizing the Prospects Maximizing the Prospects for a Successful China for a Successful China

Joint VentureJoint Venture

If a Join Venture is determined to be If a Join Venture is determined to be the best option, the following elements the best option, the following elements can help maximize the prospect for can help maximize the prospect for success: success:

• Due diligence: Thoroughly vet joint venture Due diligence: Thoroughly vet joint venture partnerpartner

• Develop a jointly agreed upon detailed business Develop a jointly agreed upon detailed business plan for the joint ventureplan for the joint venture

• Maintain control over the day-to-day Maintain control over the day-to-day management of the joint venture companymanagement of the joint venture company

• Recognize that a Joint Venture must be win-win Recognize that a Joint Venture must be win-win and that changed conditions may require and that changed conditions may require changes to the Joint Venture to insure both changes to the Joint Venture to insure both parties continue to benefitparties continue to benefit

(Continued on next slide)

•Plan carefully for dispute settlement: When Plan carefully for dispute settlement: When should mutual consent be required for action?should mutual consent be required for action?

•Plan for an orderly dissolution, in the events Plan for an orderly dissolution, in the events disagreements cannot be resolved (“Hope for the disagreements cannot be resolved (“Hope for the Best; Plan for the Worst”) Best; Plan for the Worst”)

•A good Joint Venture design should address A good Joint Venture design should address organizational differences, provide flexibility, and organizational differences, provide flexibility, and enable effective management control for both enable effective management control for both partners.partners.

If a Join Venture is determined to be the If a Join Venture is determined to be the best option, the following elements can best option, the following elements can help maximize the prospect for success help maximize the prospect for success (Cont’d) ::

Is a Legal Entity Is a Legal Entity Even Needed to Even Needed to

Establish a Establish a Presence in ChinaPresence in China??

Depending on a Company’s objectives, a Depending on a Company’s objectives, a legal presence in China may not be legal presence in China may not be needed:needed:

• Licensing of technology and distribution of Licensing of technology and distribution of products can be achieved through products can be achieved through transnational agreements between the transnational agreements between the foreign company and Chinese partners.foreign company and Chinese partners.

• U.S. and Chinese service providers often U.S. and Chinese service providers often can help manage a company’s market entry can help manage a company’s market entry into China, often more cheaply and into China, often more cheaply and effectively than a company can manage effectively than a company can manage market entry on its own, without the market entry on its own, without the company having to establish a presence of company having to establish a presence of its own in China. its own in China.

Martin LewinKALIK LEWIN

4720 Montgomery LaneBethesda MD 20814Tel: 240-744-7611

(Direct)Fax: 240-744-7601www.kaliklewin.com