Posted by Elena Luk'yanenko
Elena Luk'yanenko
Elena has more than five years of experience in international marketing providing services for the foreign com...
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on Friday, 01 July 2011
in Business in China

Initial Funding and Injecting Capital into Chinese Business

In this post, we discuss one of the hottest topics encountered by foreign companies in China: transferring and registering a company’s initial funding. The suggestions that follow are relevant to anyone thinking of establishing a Chinese business, be it a Foreign Investment Enterprise (FIE), a Wholly Foreign Owned Enterprise (WFOE) or a Joint Venture (JV) with a local company. This post covers the solutions for transferring initial funding before establishing a company and to the company bank account after company registration.

Transferring Initial Funding to a Third Party before Establishing the Company

Applying for a business license in China usually takes four to six months. Many companies cannot stand that long in order to use the funding to cover the initial costs of setting up an office, purchasing equipment, etc. They therefore prefer to transfer the initial funding to their local agent or team before they get their business license.

However, once the business license is granted and the company is approved by the government, these funds—used for establishing the company and proving that it is financially viable – are not legally considered to be a part of the company’s registered capital. According to Chinese law, any monetary transfers must be made directly between the foreign investors from a foreign bank account to a Chinese bank account set up under the company’s name for capital deposits, not by using a third party.

In a number of cases, we met investors who had transferred tens of thousands of US Dollars to local suppliers who then found it difficult to explain these transactions in the company’s balance statements, despite the fact that the money was used for rent or for purchasing equipment.  It proved difficult to show the local authorities that these purchases were part of the company’s initial funding.

Solution – temporary account and relevant regulations

We therefore advise you to open a temporary bank account right after registering the company name. You should know that there are certain limitations to the amounts that may be deposited into temporary accounts and to the transactions. These limitations vary throughout China, so we suggest that you check which regulations are suitable for the location you are applying for the business license and intend to register the company. WHERE does one check?

Minimal Capital Registration

Foreign companies apply for a Chinese business license (especially smaller companies) and often encounter another problem – capital registration. Many investments have failed since this is a very confusing and unclear issue, and it is easy to misunderstand the official term “minimal registered capital”.

This does not mean the amount of money you need to invest, since the amount of capital a business requires depends on a number of things, such as location (some places require more capital than others), the scope and field of business and business classification (some industries require more capital than others), etc. You should therefore clarify what your business would like to expand; it might require a greater registered capital.

Too many companies underestimate the importance of cash flow. This is wrong – cash flow is a critical issue. The company’s registered capital must fund the business’ operations until the business becomes self-funding. The registered capital proves that a company is financially sustainable until it has its own cash flow.

Chinese law is not always clear on what constitutes minimal capital registration. Government officials want to attract new investments and will not always tell you the whole truth. You might be tempted to accept their advice, naively assuming that you are making a great deal by accepting the official’s “minimal amount”.

We advise you to be careful. If the company’s registered capital is insufficient to support its operations until a cash flow is established, it might be forced to suddenly halt its operations.

Therefore, correctly capitalize your Chinese operations. Don’t blindly follow the government instructions relating to “minimal registered capital”, but also take the actual economic and operative realities into account. In other words, act according to what exists, not according to what should exist (information sourced from Dezan Shira & Associates).

With this in mind, here’s a tip from Zachi Lichtenblau, a partner at the Bonnard Lawson law firm, and a personal friend. Zachi says that if you take the right precautions when you register the company, you can spread out your capital contributions to the company over the first two years – as long as at least 20% of the company’s registered capital has been deposited within 3 months of its establishment.

Here’s another tip from Zachi, and this is a direct quote:

“When you register a company which will be funded by foreign investment, you will also be required to declare your “total investment” in the company. ‘Total investment’ refers to the company’s total registered capital and other funds the company may receive as loans from outside China (including funds from the parent company). Even companies who do not usually rely on loans as a source of funding are advised to determine their total investment according to the legal maximum (relative to the company’s registered capital). This is because the registration of a large total investment does not require the Chinese company to take loans from foreign sources. If the company experiences liquidity problems in China, it is always good to know that there are relatively simple ways of transferring funds to the company.”

Transferring Funds to the Company Account

If you have liquidity problems (for example, due to insufficient capital flows), there are three ways of transferring funds your company:

  1. Foreign sources (subject to the limitations on total investment mentioned above).
  2. Increasing the company’s registered capital – an exhausting procedure requiring a change in the company’s incorporation documents and an application for a new business license (which takes between 1 – 4 months).
  3. Transferring funds against a company’s own invoice – however, in this case, the Chinese tax authority will categorize the transfer as taxable income, which leads to further expenses. Avoid this – it is an outrageous waste of money.

Therefore, you should calculate the amounts you require seriously, consulting whoever needs to be consulted, sparing yourself the aggravation and the unnecessary expenses.

We at the PTL Group have helped and are currently helping many companies to successfully register in China.  However, even a successful registration is not the end of the road. It’s only the beginning of the real bureaucratic headache.

Managing a company in China is incredibly difficult. You need to manage local personnel and finances and handle the tax authorities, the Ministry of Commerce, the Ministry of Human Resources and – if you have a factory – the Ministry of Health, the Fire Department, the local governments (city/ county/ province), etc.

You can make this easier by outsourcing anything unrelated to your core business – finances, logistics, warehousing, etc. Doing this allows your local CEO to have the peace and quiet s/he requires in order to focus on the main reason for her/his relocation – whether manufacturing, sales or procurement.

Finally, we should tell you that we have seen many cases in which a company began the registration process and realized that it was too early for it to do so. We suggest that you take your time and wait for two to three years in order to see whether the requirements of your business justify the establishment of a new company. Closing a company is much more difficult than establishing it. In many cases, companies prefer to manage their Chinese operations through PTL Group’s business platform until they feel that the extent of their local operations justifies the establishment of a new company.

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