Options for Foreign Investors to Start a Business in China: Company formation VS PEO
For years, international investors have had excellent opportunities in China and have achieved excellent results in terms of their brand growth in China.
The recent pandemic has slowed down the intentions of investors, as they are concerned about the economic situation in China. However, China has managed to come out and grow again, especially in the second half of the 2020s.
But is it still convenient for foreign investors to start a business in China?
In this article, we provide an overview of the recent Chinese economic situation and the options that international investors can use to start a business in China.
- Is starting a business in China still convenient for small and medium companies?
- Options to start a business in China
The year 2020 was definitely one of the most difficult years in China. The pandemic forced millions of people to stop and start working remotely. Companies have closed their doors and many people have lost their jobs.
The Chinese government implemented restrictive measures to control the spread of the virus and little by little many companies have reopened allowing the country to close the year with positive results.
This difficult situation greatly impacted small and medium-sized companies and delayed the expansion plans of many foreign companies.
The question we want to answer now is:
“Is it still worthwhile for small and medium-sized foreign companies to invest in China?”
Since China began to open up and reform its economy in 1978, GDP growth has averaged almost 10 percent a year, and more than 850 million people have been lifted out of poverty.
Today, China is an upper-middle-income country and the world’s second-largest economy.
COVID-19 severely impacted the Chinese economy, but thanks to initial restraints, the country was then able to make up for the accumulated disadvantage in the early months of 2020 and achieve positive results at the end of the year.
According to data released by the National Bureau of Statistics in October 2020, the third-quarter GDP grew by 4.9% from a year before, bringing growth for the first three quarters of the year to 0.7 percent year-on-year.
Import and export also increased respectively by 13.9% and 9.9% in September 2020.
Some of the factors that contributed to this growth are innovation and pre-existing digitization. The shock of the pandemic had definitely reinforced the trend to more innovation and digitalization.
Regarding innovation, China retains its 14th spot in the top-performing economies in the Global Innovation Index.
The top 20 economies in the Global Innovation Index in 2020. Source: WIPO
Other measures adopted like market-oriented structural reforms, complemented with fiscal measures to rebalance the economy towards more domestic demand and especially consumption would help avoid a further decline in potential growth, reduce external imbalances, and lay the foundation for a more resilient and inclusive economy.
How to start a business in China is a question frequently asked by many users and foreign entrepreneurs.
What are the rules governing foreign investment in China?
In the Chinese legislature, there are indications regarding aspects related to how to open a business in China.
Vehicles used for this are limited liability companies (LLC) and partnerships. The LLC is the most common type of entity and is the form used for most enterprises with a foreign investment element.
China amended its Partnership Enterprise Law (with effect from 1 June 2007) to help encourage a pro-investment environment for corporate law.
But talking about foreign investments, what are the regulations for that?
About this, in January 2020 came into effect the New Foreign Investment Law in China.
Prior to this new law, foreign investors have faced issues with business establishment and treatment. Compared to Chinese counterparts, foreign investors have been restricted from investing in certain sectors unless in a joint venture with Chinese partners.
The New Foreign Investment Law (FIL) is composed of 42 articles in six chapters, focusing on foreign investment promotion, protection, and administration, and imposes legal liabilities on both foreign investors and Chinese regulators if in violation of PRC laws.
The main points are:
- Investment promotion: one of the new points is the fact that foreign investors shall be treated equally to domestic investors. Access to government funds, land supply, tax exemptions shall be the same for both.
- Investment administration: this part works together with the Negative lists to specify the areas where foreign investment is prohibited or restricted.
- Investment protection: the law clarifies that foreign investments like capital contribution, profit, capital gains, may be remitted in or out of China in RMB or foreign currency.
Regarding the ways that foreign investors have to start their own business, there are three main options:
- WFOE (Wholly Foreign-Owned Enterprise)
- Representative Office
- Joint Venture
There is actually another way that is growing in popularity. In the next sections, we will analyze these options in detail.
Moving on, there is another important question to answer…
As we have seen also before with the FIL, foreigners can have a business in China.
But of course, foreigners visiting China need to learn to handle aspects completely different from their home countries.
Different governments, different laws and regulations, different markets, different consumer habits, and so on.
Especially in choosing the right business structure to use, they need to think about the goals for their business. Questions like: “Do I need to carry out profit-making activities in China?”, “Do I need to hire staff?”, “Can I have access to government funds?”, are some of the questions that foreigners should ask before opening a business in China, so as to have then a clear idea of which type of structure to use.
The costs of opening a business in China are variable.
Much depends on the type of agency used to assist in setting up a business.
Speaking of WFOE, costs range from 100,000 RMB (about 15,000 US dollars) to less than 10,000 RMB (about 1,500 US dollars).
Depending on the price, the quality of service often differs from premium services that can help you through the whole process of setting up a business, finding an office, and providing constant assistance, to services that can only offer registration or the quality of the service itself is not the finest, leading to errors and causing higher costs and longer lead times for setting up a business.
As we could see, starting a business in China is still convenient for many companies.
The Chinese economy has resumed growth after the first few months of 2020 and the government is incentivizing foreign companies to enter the country.
But what are the ways for them to enter China and start a business?
This is the other solution that foreign companies have to start their business activity in China.
A PEO is a company that provides services under which an employer can delegate employee management tasks such as payroll, employee benefits, and workers’ compensation.
It is important to notice that in European countries or the USA, there is a differentiation between a PEO and an EOR (Employer of Record), but in China, this differentiation doesn’t exist and the PEO is also called EOR.
But why is this considered a good solution to start a business in China?
A PEO solves some of the problems that especially small and medium companies can have in China.
And these are mainly related to employment and payroll. Basically, a PEO becomes the employer of record for foreign companies and assist these with HR and payroll services.
Another reason to consider the PEO as a good solution is because it allows you to start a business in China without having a local entity. This can save cost and time to start operating in the country.
About employment, the liability of this part is shared between the PEO and the company client. This means the elimination of risk someone might face because of the Chinese laws & regulations amendments.
In addition, since the payroll calculation and mandatory benefits policies are different from city to city in China, the PEO service relieves the foreign companies from dealing with the complex processes of the payroll system and mandatory benefits, saving both time and staff.
As for the creation of the company, there are local agencies, like HROne, that can offer a PEO service in China and that are experts in local regulations about HR and payroll.
The formation of a company is certainly the best-known method of starting a business in China.
There are two types of companies:
- WFOE (Wholly Foreign-Owned Enterprise)
- Representative Office
They both come with pros and cons and I want to show you the main differences between them.
A WFOE is a privately held limited liability company in China in which all the shareholders are foreign. It is the most favored investment vehicle as it gives full autonomy and control to the foreign parent company.
There are different types of WFOE and the most common are:
- Consulting WFOE
- Manufacturing WFOE
- Trading WFOE
The main benefits of setting up a WFOE are the possibility to have full control of the company and make a profit. Full control also means that you can directly hire employees and there is no need to have a Chinese partner to form the company.
Some of the downsizes of the WFOE are the higher cost of setting it up and the time required to set it up can go up to 6-10 months.
To effectively set up a WFOE in China, you need to keep in mind that there are specific documents and processes to follow.
Some of the documents required to open a company in China are:
- Copies of passport of business license of the company in your country
- Copy of passport and photographs of a legal representative in China
- The lease contract for office in China
- Articles of association of WFOE (including business scope, name, registered capital, etc.)
The process to open a WFOE can be confusing and can lead to mistakes that could compromise the company formation.
That is why it would be better to contact local agencies like FDI China that are more expert with local law and regulations and can more easily consult with you about your needs.
A representative office (Rep Office or RO) is another option for overseas businesses to set up an operation in China.
This is usually the best option for those companies in the early stage and that want to test the market or they just need to carry out nonprofit making activities in China, like business meetings, marketing, or networking.
The time and documents required to set it up are similar to the ones for the WFOE, but as mentioned, some of the disadvantages are the fact that it is not possible to carry our profit-making activities and there is no possibility to directly hire employees.
There is no shortage of options for starting a business in China.
Company formation is the most common, but recently, many companies around the world and in China as well, are increasingly considering the possibility of using a PEO to start a business in China more quickly and save the time and cost of setting up a local company.
Here at NNRoad, we can help you gain clarity on how a PEO in China can help your company grow in the country.
Contact us for a free consultation to discuss more your needs!