Joint Ventures in China: Advantages and Disadvantages

China’s strict commercial laws dictate that western Corporations wishing to do business in China may have to partner with a Chinese entity upon arrival. Deciding what form of new corporate structure to undertake is crucial for Companies interested in entering the vast Chinese market. For some businesses, the recently curated structure of Wholly Foreign-Owned Enterprises (“WFOE”) may be the best choice, and for others, simply forming a representative office may be the ideal choice.  Today, newly-formed WFOE’s outnumber new JV’s in China. While many companies are shying away the Joint Venture structure due to the large amounts of inherent risk, it still has several advantages. These include (but are not limited to) access to land, distribution channels, business licenses, labor, networks, and Communist-party support. This post will discuss specific joint venture structures as well as advantages/disadvantages of each.

EJV vs. CJV

In an Equity Joint Venture (“EJV”) limited liability enterprise, the foreign partner holds at least 25% ownership share, with up to 20% of the total registered capital offered as industrial property rights. The EJV is a self-managed enterprise, with the top level of management typically staffed as a board of directors. The number of appointed board members by each JV partner roughly corresponds to the percent share held by the investor. Profits and losses are also distributed to each investor according the investor’s equity share. Profits may only be distributed in cash. Generally, the EJV contract must specify the life term of the EJV.

In a Cooperative joint venture (“CJV”), the final structure may take one of two forms. One form is to create a limited liability company as in the case of the EJV above. The second form is to create a contract for a specific project, without actually setting up a separate legal entity. In the first case, a board of directors will be appointed to manage the company, and they can only serve a maximum of three years. In the second case, the contract may call for a board of directors or for a management team to manage the project. In both cases, profits are paid to the investors according to the contractual agreement rather than according to the percent of investment share. Likewise, profits may be distributed in cash or products or a combination of both. The investment and setup rules for a CJV are similar to those for an EJV.

Advantages of a Joint Venture

  • Foreign companies can invest in businesses that are restricted by the government to Chinese companies. Certain sectors are reserved only for Chinese entities or JVs.
  • Chinese partner likely already has experience doing business in China
  • Ability to leverage Chinese partner’s “guanxi”, or connections, including those with the ruling party.
  • There is no need to go through the procedures involved in forming a WFOE and later deregistration of WFOE or representative office.
  • The Chinese partner can handle all application and registration matters on behalf of the JV.
  • Access to Chinese partner workforce and facilities as well as sales/distribution channels
  • Potential to avoid or reduce red tape and bureaucratic hassles

Disadvantages of a Joint Venture

  • The process of finding and negotiating with a Chinese partner can be lengthy and costly. It is best to already have a warm business relationship with potential Chinese partner
  • Intellectual Property Vulnerability
  • Certain Chinese partners may have bad contracts with relatives.
  • Sometimes ‘secret night shifts’ in manufacturing partnerships are done without the foreign partner’s knowledge.
  • The JV is self-managed, so the business plan of the company may not be carried out in accordance with the wishes of the foreign investor.
  • Proprietary technology or trade secrets provided by the investors to the JV are not well-protected.
  • Profits of the JV are shared with the Chinese partner company.

Reducing Risk of the Joint Venture

In order to mitigate risks, a foreign partner can take certain steps in abundance of caution:

  • Make clear in the joint venture agreement that the General Manager is an employee of the joint venture–not of the Chinese partner.
  • Engaging in sufficient due diligence, as though one would be investing in the foreign entity. This includes looking at the partner’s finances, partnerships, licenses, etc.
  • Ensure that the majority owner of the JV has the right to appoint and remove the Legal Representative.
  • Ensure that the party with the controlling interest in the JV has the right to control the chop.
  • Make the official version of the contract the one in Chinese, so that it has a better chance of being enforced by Chinese arbitrators and courts.

Summary

Forming a joint venture in China can be a very risky endeavor for companies who do not have a formal relationship with their potential partner or extensive experience in working in China.  A JV (either an Equity Joint venture or Cooperative Joint venture) is typically best formed when proper diligence is made, and the foreign entity is attempting to enter a heavily restricted industry.  In this instance, the Chinese partner’s market knowledge and resources are often crucial to successful expansion into China.

Kris Khalil
A.B. Freeman Business School, Tulane University