Just cc’ed on an email from one of my law firm’s international corporate lawyers to a new client for whom we have been retained to form a China Wholly Foreign Owned Entity, or WFOE. One of the things that so often surprises people is how difficult it is to form a WFOE in China. This email goes a long way to explaining what is involved with forming a China WFOE and why it tends to be so complicated and time consuming.
Thank you for engaging us to assist with the formation of your China WFOE. I will be overseeing this project with the assistance of various lawyers in my firm here in the United States and in China. I have set forth below the preliminary information and documents we will need. Depending on the exact nature of your activities in China and the requirements of the local government, we may need additional information at a later date, but this will be a good start.
1. Please state the identity and contact information of the proposed WFOE shareholder(s). At minimum, we will need each shareholder’s legal name, legal address, the state and country of formation, and the state and country of the principal place of business. Once we determine the ownership structure of the WFOE and the identity of the WFOE’s shareholder(s), I will ask you for a number of corporate documents.
2. Some of our clients elect to form a Hong Kong company as an intermediary company, so that the sole shareholder of the WFOE is the HK company, and the sole shareholder of the HK company is the US company. At one time forming a HK company made it significantly easier to move through the initial stages of the WFOE formation process, but these days it’s pretty much a wash. Also, although forming a HK company is relatively easy and cheap, it’s another corporate entity and as such will require ongoing maintenance: annual reports, taxes, renewals, and so forth. Forming a HK company also requires opening a Hong Kong bank account, which often requires that a director of the HK company go to Hong Kong in person.
The main reason to form a Hong Kong company these days is for tax reasons, particularly if you anticipate that the China WFOE will become a profit center and remit substantial sums back to its parent company. Based on our conversations to date, I don’t think this is what you have in mind for your China WFOE. Still, I would advise that you (and I) speak to your accountants on whether your tax situation will make it a good idea to form a Hong Kong company.
3. Have you determined a location for the WFOE? If you have already have a proposed office address, please provide it, along with the name and contact information of the landlord. If you haven’t yet determined the exact address, then provide the city and district (e.g., Huzhou, Wuxing District).
4. If you have a lease or proposed lease for the office space, please provide that document. Note that the lease should be valid for at least one year beyond the eventual approval date for the WFOE. As the WFOE may not be approved until several months hence, it is best for the initial term of the lease to be at least a year and a half, with 2 years being even better. The lease should also be in a proper format, and typically will need to be registered with the local real estate authority. We will work with you on this.
5. We will also need proof that the landlord owns the property and has the authority to enter into the lease. This is usually proved by provision of a land rights certificate and documentary proof of existence from the landlord (i.e., a national ID for an individual, and a business license for a company).
6. You will also want to make sure that your proposed use is acceptable for the premises and that the premises are suitable for use by a foreign-owned entity. It used to be possible to check these things with the local SAIC, but this information is no longer publicly available. Accordingly, we will need to make sure the lease includes provisions protecting your interests in this regard – that is, a guarantee from the landlord that the premises are suitable for use by a WFOE and for your proposed use, and a requirement that the landlord cooperate with any requests for documents, receipts, or certifications. We have model language (in Chinese) that we use for this.
7. As part of the WFOE formation process, we will review the lease to make sure it is suitable for use by a WFOE, contains adequate protections for you during the formation process, and is properly executed. Though we would also be happy to conduct a substantive review of the entire lease, or negotiate with the landlord on your behalf, this would be outside the scope of our engagement and we would charge on an hourly basis for such work.
8. Please provide four proposed company names in Chinese, in order of preference. The shorter the better; if possible, use no more than four characters. For now, we only need the basic name (e.g, “Nike,” not “Nike, Inc.”) We will then work with the local authorities to determine what should be the full legal name, which will likely include the scope of business and the location. Note that the Chinese authorities are primarily concerned with your WFOE’s Chinese name. The WFOE’s English name will be unofficial and is, for the most part, up to you.
9. Please prepare a one-page summary of your WFOE’s activities. This is not a mission statement but rather a narrative that should include the following:
(i) A general description of the business conducted (i.e., the services and/or products provided)
(ii) How the services and/or products provided will change over the 5-year period following formation;
(iii) How it will be staffed (e.g., the number of employees upon formation, how that number will change over the next 5 years, and the citizenship of each employee);
(iv) Job descriptions for each employee and an explanation of how the employees will be managed;
(v) A general description of the customer base;
(vi) The cashflow model for the WFOE. That is, from which entities will the WFOE’s income come from? How will this income be generated? Will the WFOE’s income stay in China or be paid to an entity in another country? To which entities will the WFOE’s expenses be paid? For what purpose will these expenses be paid? What are the estimated amounts of such inflows and outflows? In what currency will payments to/from the WFOE be made?
(vii) A detailed first-year cost projection.
(viii) A one-year and five-year pro forma income statement and balance sheet.
(ix) A statement of the amount of “total investment” and the amount of “registered capital,” if not contained in one of the above financial statements. Registered capital is money that the parent company must contribute to the WFOE after formation. By contrast, total investment is the amount of registered capital plus the amount of (optional) debt financing that the WFOE can take on. There is no requirement that the WFOE raise any funds through debt financing; however, having a total investment amount higher than the amount of registered capital gives WFOEs flexibility with debt financing that, from a regulatory standpoint, they would not ordinarily have. Typically, any such debt financing is simply a loan from the parent company. (Note that if a WFOE needs an influx of cash from its parent company, a loan is usually preferable to a payment, as the latter will be treated as income to the WFOE and taxed accordingly. The relevant Chinese regulations state that for lower-capitalized WFOEs (i.e., those with total investments of less than US $3 million) the amount of registered capital must be at least 70% of the amount of the total investment.
10. Please describe the WFOE’s management structure. Will it have (1) a board of directors or (2) a single director (called the managing director or executive director)? Once you decide that, we will need to know the identities of the following WFOE personages:
(i) Managing/Executive Director (or all the Directors, if you have a board): This person is in charge of overall management of the company, but not day-to-day management.
(ii) General Manager: This person is in charge of day-to-day management of the company—making bank deposits and withdrawals, paying taxes, arranging utilities, hiring and firing, and so forth. As a matter of law, the general manager and the managing director can be the same person and do not need to reside in China. As a practical matter, for any company actively operating in China, the general manager should be resident in China.
(iii) Supervisor: This person has nothing to do with the day-to-day operations of the WFOE. The supervisor merely represents the interests of the shareholders, and oversees the actions of the managing director (or board of directors, if you have a board). In a one-shareholder WFOE, as here, the supervisor does next to nothing, but Chinese law still requires that one be appointed.
(iv) Legal Representative: This person has overall responsibility for the management of the Chinese company, and is vested with the authority to act in the name of the company. The “legal representative” is a position unique to China corporations; the closest analog in American corporate structure is the chairman of the board. By definition, the legal representative has authority to sign contracts on behalf of the company. The legal representative is not a standalone position; he or she is virtually always either the chairman of the board (for a three-person board) or the managing/executive director (for a one-person board).
11. Note that though the same person can simultaneously serve as the managing director, legal representative, and general manager, that person cannot be the supervisor. The supervisor must be a separate person.
12. Please provide color copies of the passports of the above people and a current resume of the WFOE’s legal representative.
The first step in WFOE formation is to apply for registration of the WFOE company name. But before we can do that, we must first finalize both your company’s scope of business and the exact location of the office, because the address of the office determines where we must submit the WFOE application. Additionally, the specific procedures for WFOE formation vary depending on the city and district in which your office will be located, and on the scope of business. In other words, the first step itself requires a considerable amount of preparation.
Once we determine which entity will be the shareholder of your China WFOE, I will send you another email with some additional questions. We will keep you informed of the status of your WFOE throughout the process, and you should feel free to contact me or Grace at any time with questions. That being said, the WFOE formation process is long and inefficient, and can be frustrating for foreign investors. It’s a marathon, not a sprint.
I look forward to working with you on this project. Don’t hesitate to contact me should you have any questions.