SMEs
join the race to China, but have they done the required training?
The race to get into
China is on. Foreign manufacturing companies have bunkered down in
the South, international banks and insurance companies are vying for
territory in Shanghai's new financial playground, global technology
firms are flocking to 'state-of-the-art' high-tech parks in Beijing
and a multitude of NGO's are gearing up to provide much needed education
and poverty-relief programs in the West.
Yet, where
and how do the small-medium sized foreign enterprises (SMEs) fit into
the picture? How do smaller companies who want to tackle the
largest potential consumer market in the world play with the big-boys?
Unfortunately many such
companies have learnt their China lesson the hard way - through Joint
Venture partner arrangements gone wrong, through losing their one
core asset, Intellectual Property, and even having their investment
eaten away from under them through over-trust and under management.
So, what are the danger
signs for SMEs to beware of? What is to stop them from investing in
a rotten venture when they don't have the resources to protect themselves?
How do they compete without the huge PR budgets or government connections?
In a nutshell - how can SMEs tell what is a
rotten onion and what is not?
Safeguarding
against buying a rotten onion!
There are essentially 6 key rules
to abide by:
1. Conduct
appropriate research - The market research and 'credit
check' industries in China are booming. Greater publicly-available
information, more open government channels and a more mature services
industry, ensure that companies now have access to greater insight
about the market, geographical segmentation, consumer behaviour and
competitor analysis.
Aside from understanding the market,
it is also a pre-requisite in China to intimately know your partner
(whether business partner or simply a key supplier) and also possibly
key employees. The most effective way to do this is through "background
checks". This can be done efficiently
and discretely.
Checks should be prepared from two
angles:
a) Personal checks - With
political connections playing an integral role in business in
China it is almost mandatory for investors to evaluate their partners,
suppliers or key personnel to understand
possible government relationships. Many companies have
partnered with a seemingly influential 'business person', only
to find out later that the same person is the Mayor of the city
and once he resigns (and his connections follow) they are harassed
by tax authorities to pay back enormous tax liabilities previously
disregarded.
b) Company checks - This
is particularly important when venturing with or potentially
purchasing a local (Chinese) company. Under current accounting
and auditing regulations, there are different requirements for
Foreign Invested Enterprises (FIEs) and local firms. One important
distinction is that local firms are not required to be audited
by an independent CPA firm. As a result, many investors have jumped
into bed with, or entered into supplier arrangements with theoretically
bankrupt partners or those with a lot of skeletons in the closet.
2. Know the
regulatory environment - In China there are essentially
four structures that investors can use to set-up operations:
a) Representative Office;
b) Joint Venture;
c) Wholly Foreign Owned entity;
or,
d) Domestic company
Whilst the first
three are available to foreigners, the last is only available to Chinese
citizens (or through the
equivalent of a nominee-holding structure).
In deciding which structure is best
for your operation there are, of course, business decisions to be
made and also legal issues to consider.
The key ones for SMEs to consider
are:
a) What will
your business scope be?
b) What structures are allowable
in your industry and business scope?
c) Who will your clients be - local
or international?
d) Do you wish to trade in China
or is the entity purely for sourcing opportunities?
e) Are you required to invoice in
China or will your business be conducted offshore?
f) How will
you repatriate profits?
g) How much do you wish to invest
- There are certain "minimum capital requirements" for certain
structures, depending on your business scope.
h) How will you pay your payables
(offshore or onshore)?
Adding to this complexity is the decision
on how to enter the structure. With China's
developing Merger and Acquisition market, a massive sell-off of State
Owner Enterprises (SOEs), new tax changes to China Holding Companies
(CHCs) and the ability to hold operations offshore, it is no longer
a requirement for foreign SMEs to establish "Greenfield" operations
in China.
3. Where to set up your operations
- This decision will not only depend on your business requirements
(e.g. being close to suppliers), but more importantly, on government
policies in different locations and available preferential tax policies.
In Beijing alone there is "one
district and five parks" all
offering foreign investors with substantial tax concessions. Where
as concessions were once a despised word in China (Shanghai) after
the Opium Wars, they are now back in flavour. Special Economic zones,
coastal cities, high-tech parks, manufacturing bases and government
"Go West" policies are proving enormously successful in luring foreign
investment.
However, it must be warned that there
is still a cloud of uncertainty over the authority of some districts
offering these incentives. Therefore, it is highly recommended that
advice is sought before agreeing to something
that the local tax authority is not actually authorized to deliver.
4. Setting
up the business - Companies in more developed nations
(such as Hong Kong, Australia, USA) can be established within hours.
This is not possible in China. The maze of government bodies and approval
processes are simply mind-boggling and add to the costs and time to
actually establish a legal entity.
Once a company's business license has
been approved (which in itself can be a complicated process),
there are still nine government bodies (depending on location
and the business) which the company must register with! All must be
completed in a specified order and they all require separate applications
and approvals.
As
such, the length of time between deciding to invest in China and actually
having an established enterprise may take a number of months.
5. Intellectual Property (IP) -
China's IP protection is improving. Whilst many companies still find
themselves being caught out with their partners or competitors running
off with their brand name, trade secret or product plan, it
is very often the own fault of the company itself. In China
you must register all trademarks and patents. It is that simple.
This is a relatively inexpensive and
trouble-free task. China operates on a 'first-to-file'
basis and, as such, companies should undoubtedly register their IP
before they even think about setting foot in the country. This is
particularly important for SMEs which may not have world-wide registered
IP.
Many foreign firms, especially SMEs,
decide that their first enclave to China will be through setting up
a stand at a trade fair. This may indeed prove invaluable for establishing
business relations and 'getting a product out there', but it also
provides invaluable opportunities for unscrupulous businesses to take
a brand name or product idea and cash-in on it, albeit legally, through
registering the IP first. In fact, many foreign companies have
shown up to the same trade fair the next year only to see their brochure,
let alone their brand name and a similar product, in the next booth.
6. Operations
- China is undergoing rapid reform of accounting, taxation
and legal systems. The end result of this will see a more transparent
operating environment. However, in the meantime the changes (with
new legislation being produced about every 6
days) is proving near impossible for SMEs (with limited internal
accounting, finance and law departments) to keep abreast of.
China is, as most large multinationals
will 'unwillingly' admit, a difficult enough place to make money without
having to worry about corporate compliance and nosy taxation authorities.
Long lunches with officials, use of government connections, and unnecessary
trips to the tax departments should be a thing of the past бн but unfortunately
for many it becomes their "core business".
It is easy enough to
comply with regulations in China if the correct procedures and expertise
are put in place. Things, though,
can turn very unpleasant if rules and regulations aren't adhered to
- regardless of whether they are broken innocently or in contempt.
An efficient and effective method for
small-medium sized enterprises to ensure that their operations are
in compliance in China is to either:
a) Outsource part or the entire accounting
function; and/or,
b) Engage an external professional
services firm to act in a financial oversight (CFO) role.
This allows
the enterprise to concentrate on their core business and not be concerned
with the constantly changing corporate regulations in China.
The
final word
As
the 2008 Olympics draws nearer, the race for the China market, and
a place on the world podium is certainly there for many SMEs to take.
The biggest hurdle for such companies still remains understanding
the playing conditions, adjusting to the prevailing winds and keeping
onside with the umpire.
By
following these simple rules you may avoid your company being the
one caught with the rotten onion when the final whistle blows!
Cameron Hume, LehmanBrown,
Beijing
