Funding methods in China for Foreign Invested Entities
At first glance, one might think that financing an entity happens the same way everywhere in the world. In China, this belief can lead to some inconvenience.
These assumptions cause some companies with great potential in China to run into unanticipated problems such as running out of money, or inadvertently violating specific Chinese investment regulations, or unintentionally over-investing and trapping cash unnecessarily in China with challenging corrective actions available.
One of the classic pitfalls into which European companies fall regularly is current account financing. This practice, which is widespread in Europe, is a source of difficulty on several levels. The incorporation of a foreign fund company in China is considered by the Chinese authorities as a parent company which implies the taxation of current account financing between an “investor” and the Chinese company in which it has invested.
Funding levers are as follows:
- Registered Capital
- Foreign Debt
- Business operations
- Related-party loan in China
- Third-party loan in China
1. The registered capital is defined and capped in the Articles of association of the company and shown in the Company’s business license. It’s an investment that can be used in the normal business activity to buy equipment, pay rent, or employees but be aware that banks and the administration in charge of foreign exchange (SAFE) will control this flow of foreign currency. The anticipation before using it will therefore be necessary.
For a foreign-invested company, the registered capital is normally labeled on foreign currency (non CNY). The registered capital can also be satisfied by contributing with assets or expenses already made for the company but in practice, the recognition of the value will be lowered significantly. Also, this process of recognition by the authorities is more and more difficult to be validated by the authorities.
2. Foreign debt is determined and capped in the Articles of association of the company by metrics which are the difference between the registered capital and the total investment. The base is the registered capital with an additional “Foreign debt” that will be the total investment. The percentage of “Foreign debt” is capped by the regulation. From 30% under $3M to 67% for more than $30M.
This funding possibility will also need to be anticipated and monitored as the process should be followed to have the “Foreign debt” validated by the authorities in charge. Due to these limits, it is highly advisable to prepare a regular forecast of cash requirements until the activity becomes financially independent.
3. Business operations are for sure the more natural way of funding and showing a healthy activity. To do that, the company should become cash flow positive. Sometimes, the choice is made to have only a center of costs in China. For this kind of set-up, it is always good to have a minimum activity in China to limit cash movement between foreign countries (outside China) and China.
4. The related-party loan can be a possibility but only inside China, doing it with a party in a foreign country will make it recognized as revenue from the Chinese side. This is an interesting way of financing with a limitation of risks.
5. The third-party loan will be also efficient only in the Chinese territory. Even if it is possible, this is very rare and difficult to have a loan from a Chinese bank for Foreign Invested Entities as the Chinese bank can ask for seizable assets locally to approve a loan.
We did not add it on the funding levers below as it is more clearly Chinese Invested Entities technical levers, factoring can be a Business operation funding by anticipation, to avoid a cash flow rupture, for secured assets as clearly manageable accounts receivable.
For a more in-depth analysis of the best option based on your situation, feel free to contact us. After the analysis, we will be able to process for you the full scheme we proposed above.
