Selling Your China WFOE: Yeah, That’s the Ticket

1. Selling a China WFOE

In the last year or so, our China lawyers have been seeing a steady increase in emails from people inquiring about selling their China WFOEs. I have gotten three or four of these in the last month alone, including the following one this week, which is fairly typical:

I have a shelf WFOE and I am looking to sell it and would be grateful if you could let me know whether you can assist. I look forward to hearing from you soon.

We have been getting so many of these lately that I’ve set up the following as my “push button” (literally) response:

It is the extremely rare WFOE that can be sold simply because they are so limited geographically and by business scope and because they come with so many risks. What is your business and in what city is it located and does it have any employees and why are you seeking to sell it?

As China’s economy continues to contract and as doing business in China continues to get more expensive and complicated, we expect the number of foreign companies looking to leave China to continue growing. Foreign companies leaving China often means trying to sell or shut down their WFOE, neither of which are at all easy.

2.  The China WFOE Market

Is there really a market for existing WOFEs? We have been operating for five years now and we are certainly fully aware of how hard it is, but I do not intend to quit, but certainly there will come a time when we need to exit China. One option is sale, but I really doubt that is possible. Does anyone know of examples? Also partial sale to key staff, for a peppercorn perhaps, seems to be a good idea from a business point of view. Does anyone know if this is possible?

We responded as follows:

Not much of a market at all. The problem is that to buy a WFOE requires the buyer essentially want to do exactly what the seller has been approved to do. So for example, if I want to do a consulting business in Qingdao, I must buy a consulting business in Qingdao. And then I also have to make sure the costs of due diligence on the WFOE and the risks of buying into the liabilities and problems of the WFOE, do not outweigh the advantages of taking over a WFOE, as opposed to forming a new one.

We then wrote how it is possible to sell a WFOE and of how our China M&A lawyers have been involved with a couple such sales and they are easy from a legal perspective, but they are difficult to justify from a business perspective. We sometimes see WFOE sales to employees (both expats and Chinese citizens) who want to see the WFOE keep going so they can hold onto their jobs. It is possible to sell a WFOE to a Chinese company or a Chinese citizen (and this would include to an employee) and then it converts to a Chinese domestic company. This too is pretty routine legally, but such sales are rare because usually the employee knows exactly why the WFOE is closing and usually the employee can choose to essentially take over the WFOE after the foreign company has left, and do so “informally” and without any payment.

3. The Difficulties in Selling a China WFOE

You can sell your WFOE to a foreign company looking to do business in China, but that too has all sorts of difficulties, many of which we detailed in a previous post, entitled, Buying And Selling China WFOE Shell Companies.

In that post, we talked of how our China attorneys are always getting emails and calls from someone asking us if any of our clients might be interested in buying a China WFOE and of how our usual answer is “no.”

The people trying to sell their WFOE usually tout it as being completely liability free and therefore ready to go much faster and at a much lower price than if someone were to have to form their own China WFOE. For what it takes to form a WFOE in China, check out the following:

If you read any of the above posts, you will no doubt conclude that forming a WFOE in China is a convoluted and time consuming process, and it is. Therefore, buying an off the shelf WFOE must be much easier, right?

The thing about off the shelf WFOEs is exactly that: they are off the shelf and not customized. And that is where the problems arise. Let’s take as an example a WFOE that someone tried to interest me in many months ago. That company was in the IT outsourcing business in a second tier city. So right there, its only real potential buyer is someone who is interested in doing IT outsourcing in that second tier city.  Because if the buyer of that WFOE is interested in doing anything other than IT outsourcing, it will need to petition the government to expand or change its business scope. Similarly, if the buyer is interested in doing IT outsourcing in some other city, it will need to petition the government to move its WFOE or it will need to set up a branch in that other city, and thereby have to maintain two offices. When you throw in the fact that anyone buying a WFOE will need to conduct due diligence on it to make sure it truly does not have liabilities of any kind (including, tax, employee, environmental, tort, etc.) you can quickly see why forming a new WFOE will usually be safer and as fast and cheap as buying one. The biggest benefit in buying a shell WFOE would be speed, but it is going to be the rare instance where saving a few months will warrant the extra risk.

4. WFOE Scope is Key

Do not underestimate the importance of getting the scope of your WFOE exactly right, whether you are buying a WFOE or forming one from scratch.

We are getting an increasing number of calls from American companies in trouble with the Chinese government for doing things in their business that they did not mention in the business scope section of their initial WFOE. In some cases, the companies have admitted to us that they were never “really comfortable” with the business scope mentioned in their applications, but that the company they had used to form their WFOE had “pushed” them into it as it would “make things easier.” In some cases, the scope of the business changed after the application was submitted and the company had failed to secure approval in advance for the change. And in some cases, the WFOE. likely would not have been approved had it been upfront and honest in its application.

In nearly all instances, the companies had managed to secure local approval but were now in trouble with Beijing, which constantly audits these applications. In one instance, the local government went back and changed its mind, probably after conducting its own audit. Either way, it’s no fun to get a knock on your door by Chinese government officials giving you 30 days to shut down your WFOE and leave town.
Applying for a WFOE in China involves a lot more than just filling out a form and getting approval. It matters for what you get approved and you (or whomever you are using for your WFOE application) need to know China’s foreign investment catalog inside and out before applying. You then must tailor your application to meet both the requirements of the foreign investment catalog AND the reality of what you will be doing in China. A failure to comply on both fronts will lead to, at best, a rejection of your application and, at worst, being shut down months or years later.
The odds of a shell WFOE’s city and scope lining up perfectly with that of a potential WFOE buyer are low and we are not aware of any website that tries to match up WFOE sellers with potential WFOE buyers. The fact that there is no such website speaks volumes for the lack of a market.

So yes, buying a WFOE is possible, but difficult. But we do find the idea of selling a WFOE to an employee appealing as it can make for a smooth transition all around. But the real question (again) is not the legalities, it is the practicalities and the desires.

Years ago, the China Business Hand [link no longer exists] wrote about his efforts to sell a WFOE in 2005. As he put it, he “could close the business and walk away or try to sell it, but it turned out that neither option was simple or straightforward.”

At first, Barru thought closing down his WFOE would be easy, but it being China, he was wrong about that:

Closing down the business and moving on seemed the easiest way out. Until I discovered that terminating a WFOE license involved getting approval to do so from the long list of government agencies that had approved the license in the first place. To make matters worse, shuttering the business would cost me around $2,000 in fees of one kind or another.

If I had been leaving China altogether in 2005, I would have settled up with my two employees, gone to Hong Kong to convert the company’s remaining Chinese funds to US dollars, and gotten on a plane home, letting Chinese government officials sort out what to do with an abandoned WFOE. Alas, my new job was in Beijing, so this was not an option.

I went to the primary licensing authority, the Bureau of Industry and Commerce, to ask if there was a formal procedure of some kind to make the company inactive (aka: a shell company). Nope. As long as the company existed, I would have to file monthly tax reports, complete the statutory annual audit and license renewal procedures, and meet all of the many reporting requirements of other agencies. The fact that the company would not be engaged in any business activity made no difference whatsoever.

It being so difficult and expensive to shut down his WFOE, Barru then sought to sell it, which too proved difficult:

Selling the company, even for next to nothing, quickly moved to the head of the line. But transferring the business license and my legal person status to the wannabe new owner involved far more than filling out a couple of forms.

It was the buyer who had to jump through the bureaucratic hoops. For all intents and purposes he went through the same process one goes through to establish a WFOE. With one key difference – he did not have to invest new capital in the company. The original US $70,000 in registered capital (that I had put in and had later managed, for the most part, to take out) was all that was required. Since registered capital for a WFOE had increased to US $200k by 2005, there were demands for additional investment, but rather convoluted negotiations eventually got around this obstacle. Fortunately, the buyer was located in Nanjing. The need to move the WFOE to a new locale would have been a deal breaker.

Eventually, after several months of discussions and chopping forms, all the questions about registered capital, business scope of the company, the good character of the new owner, and the license transfer had been answered and the sale was complete. The price probably covered my express mailing costs and bought me a couple of dinners. But I was out from under what had become an enormous, very time consuming headache.

As Barru so accurately observes, forming and running and even closing a business in China is going to require you to get up close and personal with your local bureaucrats:

The fact is, when you are doing business in China, the local government where you operate is your de facto partner. Chinese bureaucrats were involved in every aspect of my business over the years, sometimes in reasonable ways but on occasion as meddlesome pests sticking their noses into strictly business decisions. Even the end of my days as a WFOE owner involved getting government officials to, in effect, give me permission to let my business go.

The same holds true today. In a subsequent post we will discuss what it takes to shut down a China WFOE and why just “walking away” from your China WFOE is usually a really dangerous thing to do.