There are many strategic choices to be made when first entering the China market. You will need to decide whether to launch your business by establishing a legal entity with a capital investment in China or to start more cautiously by testing the market, building networks or hiring local representatives.
This article tries to clarify the options available for creating a ‘real’ physical presence in the Chinese market. We will discuss some strategic choices that could limit your choices and we will highlight the possible advantages (and limitations) of certain options.
There are three main ways to establish a physical presence in China. One is the Representative office (RO), while the other two – colloquially known as a Wholly Foreign Owned Enterprise (WFOE) or a Joint Venture (JV) – fall under the umbrella of Foreign Invested Enterprise (FIE).
Representative Office (RO)
A Representative Office (RO) can (as “it says on the tin”) represent the interests of a foreign investor by acting as a liaison office for the parent company. There is no minimum investment requirement because an RO is not considered to be a separate legal entity.
So, yes, an RO provides a physical presence but it is not a separate legal entity and therefore does not offer limited liability. More importantly, it is not permitted to engage in any commercial activity. It can only conduct market research, develop and maintain partnerships and business channels.
An RO may therefore be suitable for businesses that are looking to establish a presence in China and have no need to generate revenue; for example, to manage government relations or focus on quality control. However, an RO should not be regarded simply as a way for new entrants to China to minimise their exposure.
Foreign Invested Enterprise (FIE)
A FIE is the general term for any entity in China that has a foreign investor.
A WFOE is a Limited Liability Company (LLC) that is fully invested by one or more foreign investors (either overseas entities or individuals). A clear advantage of a WFOE over an RO is that a WFOE can engage in commercial activities and is a separate legal entity with limited liability.
A JV is also an LLC but the ownership is split between one or more domestic (Chinese) investors and one or more foreign investors. As a result, a JV is permitted to operate in many more business sectors or activities than are available for WFOEs. That being said, a JV is the most complex entity to set up in China.
The differences between these three options are summarised in the table below:
So how do you choose between a RO, WFOE or JV? In some instances, the choice is made for you. If the goal is to enter a restricted industry (like telecoms, for instance) and a physical presence is required, then a JV is most often the only choice. However, it is not always that clear.
This is best explained by ways of a few examples:
- A car parts’ manufacturing firm can, in most cases, enter the market using a WFOE. However, it may decide that establishing a JV with a Chinese domestic partner will increase its chances of success in China.
- An overseas company that has an original equipment manufacturer (OEM) relationship with a Chinese manufacturing company wants to have a physical presence in China to conduct on-site quality controls. There is no need to have commercial capability in China, so an RO may be a good option. But choosing a WFOE would offer more flexibility in the future if starting commercial relations in China were to become an option.
- A telecoms company that provides services to Chinese telecoms companies outside China wants to establish a presence in China in order to manage these relationships better. A WFOE could work here, but as the firm’s commercial relations will run directly with the overseas business, an RO would be the best fit.
This article has taken the need for a physical presence in China as its starting point, but there are other ways to enter the market. Should you be considering a distributor or licensing model instead?