Establishing a Presence in China for Marketing and Other Business Purposes: Joint Ventures versus Going It Alone

1. Establishing a Presence in China for Marketing and Other Business Purposes: Joint Ventures versus Going It Alone Green Trade Network Summit Monterey Bay International Trade Association September 19, 2008 Martin Lewin, KALIK LEWIN

2. What is a Joint Venture?

3. A Joint Venture is a generic term loosely referring to any association of persons or companies jointly undertaking some commercial enterprise • Typically in a Joint Venture the participants contribute assets and share risks. • Often the Parties create a separate legal entity for the commercial enterprise. • A Joint Venture can be a partnership, a corporation, or some other limited liability company, depending upon tax, liability and other considerations.

4. Do you need to enter into a Joint Venture to do Business in China?

5. There are three legal structures available in China under which foreign companies can conduct most kinds of business: • Equity Joint Ventures • Cooperative (Contractual) Joint Ventures • Wholly Foreign-Owned Entities In addition, foreign companies can conduct limited business operations (i.e., market research but not sales) through a Representative office.

6. Key elements of Equity Joint Ventures: • Profit and risk sharing are proportionate to the equity of each partner in the joint venture, except in cases of a breach of the joint venture contract. • A minimum of 25% of the capital must be contributed by the foreign partner(s). • There is no minimum investment for the Chinese partner(s). • Share holdings in a joint venture are usually non-negotiable and cannot be transferred without approval from the Chinese government. • Either party can hold the position as chairman of the board of directors. • Equity can include cash, buildings, equipment, materials, intellectual property rights, and land-use rights but cannot include labor.

7. Key elements of Cooperative Joint Ventures: • Parties involved may operate as separate legal entities and bear liabilities independently or may be registered as a limited liability entity resembling an equity joint venture in operation, structure, and status. • No minimum foreign contribution is required. • Contributions are not required to be expressed in a monetary value and can include labor, resources, and services. • Profits are divided according to the terms of the cooperative venture contract rather than by investment share • The foreign investor is permitted to withdraw all or part of its registered capital during the duration of the cooperative venture contract. • Trade unions must be allowed to represent the employees in employment matters .

8. Key elements of Wholly Foreign Owned Enterprises: • Registered capital must be subscribed and contributed solely by foreign investor(s). • Business scope must be defined. • WFOE can only conduct business within its approved business scope. • Amendments to the business scope require further application and approval.

9. Chinese authorities encourage Joint Ventures in order to obtain exposure to advanced technology and new management skills. However, Joint Ventures are not required for foreign company participation in most industry sectors

10. When can a foreign company conduct business as a WFOE?

11. Basic information on the requirements for foreign investment can be found in “the Catalogue for the Guidance of Foreign Investment Industries” published by China’s State Development and Reform Commission. • The Catalogue classifies industrial sectors as "encouraged," "restricted" or "prohibited" • Category coverage is comprehensive and precise, including 351 encouraged industry sectors, 87 restricted industry sectors, and 40 prohibited industry sectors • Industries not specifically identified fall by default under the "permitted" category. • If a particular project falls under the "encouraged", "permitted" or "restricted" category, foreign investors can invest in a project as long as the appropriate level of government approval can be obtained and the investment complies with applicable restrictions on foreign ownership. • Direct foreign investment is not allowed in projects classified as "prohibited".

12. WFOEs are allowed in almost all encouraged and restricted industry sectors listed in the Catalogue. Key exceptions include: • Development and application of new technologies that can increase the recovery factor of crude oil (limited to equity joint ventures or contractual joint ventures) • Production as well as research and development of certain automobile electronic devices, including, among others, power cell (NiH and Li-con) and control systems (limited to equity joint ventures);

13. WFOEs are allowed in almost all encouraged and restricted industry sectors listed in the Catalogue. (Con’t) Key exceptions include: • Power transmitting and transforming equipment (limited to equity joint ventures and cooperative joint ventures): non-brilliant form transformer, high voltage implement great bushing, high voltage on-off operation implement, and freedom integer arc contact, direct current transmit electricity dried reactor, 6 inch direct current convertor clique high-power grain-valve tube, electrical apparatus contact material, and non-Pb, non-Cd solder accorded with EU command of RoHS • Manufacture of the equipment of new energy electricity-power (limited to equity joint ventures and cooperative joint ventures): photovoltaic power , geothermal power generation, tidal power generation, wave power generation, rubbish power generation, methane power generation, wind power generation over 1.5M

14. Wholly Foreign Owned Enterprises are authorized to invest in: • Construction and operation of electricity power by employing the clean fuel technology of integral gasification combined circulation (IGCC), circulating fluidized bed more than 0.3 million kw, Pressurized Fluidized Bed Combustion Combined Cycle(PFBC) more than 0.1 million kw. • Construction and management of hydropower stations with the main purpose of power generating. • Construction and management of new energy power plants (solar energy, wind energy, magnetic energy, geothermal energy, tide energy and biological mass energy, etc.). • Utilization of sea water (direct use of sea water, seawater desaltation), using industrialization to recycle industrial sewage. (Continued on next slide)

15. Wholly Foreign Owned Enterprises are authorized to invest in (Con’t): • Construction and operation of urban water-supply plant. • Technology for recycling and comprehensive utilization of resource, development and application of the recycling technology of the waste dispelled by enterprises. • Technology for environment pollution treatment and monitoring.

16. Joint Ventures versus Wholly Foreign Owned Entities: Which Way to Go?

17. There are advantages to establishing a presence in China through a Joint Venture. • Overcoming a lack of familiarity with China’s business and legal environment. • Gaining access to the JV partner’s knowledge base. • Lowering capital costs. • Addressing human resource issues. • Gaining local community and government support.

18. There are significant potential downsides as well. • Significant time and resources are needed set up a joint venture and to oversee it. • Local partner’s objectives may be different than the foreign company’s. • Cultural differences may lead to misunderstandings and operational conflicts. • Potential loss of control over day-to-day operations. • Local partners have many ways to profit personally without the Joint Venture itself making any profit.  • Foreign company may lose control over intellectual property. A Study in the 2004 Harvard Business Review reported that 48% of nearly 1,600 international joint ventures ended in failure in less than two years’ time.

19. Advantages of a WFOE: • Autonomy and independence to carry out strategies without having to consult their Chinese partners • Operations and management efficiency • Full control over management and profit distribution • Safeguard Intellectual Property

20. As a general rule, choose the simplest structure that accomplishes the company’s objectives. Even where collaboration with Chinese partners is needed, consider accomplishing this by long-term contracts: Purchase/sale; licensing; distribution, etc. Think of Joint Ventures as a last option, except where both the foreign company and Chinese partner will be contributing substantial assets (e.g., technology, land, buildings, equipment), long-term planning and operations are required, and objectives and operational modalities are clearly understood and agreed upon.

21. Maximizing the Prospects for a Successful China Joint Venture

22. If a Join Venture is determined to be the best option, the following elements can help maximize the prospect for success: • Due diligence: Thoroughly vet joint venture partner • Develop a jointly agreed upon detailed business plan for the joint venture • Maintain control over the day-to-day management of the joint venture company • Recognize that a Joint Venture must be win-win and that changed conditions may require changes to the Joint Venture to insure both parties continue to benefit (Continued on next slide)

23. If a Join Venture is determined to be the best option, the following elements can help maximize the prospect for success (Cont’d) : • Plan carefully for dispute settlement: When should mutual consent be required for action? • Plan for an orderly dissolution, in the events disagreements cannot be resolved (“Hope for the Best; Plan for the Worst”) • A good Joint Venture design should address organizational differences, provide flexibility, and enable effective management control for both partners.

24. Is a Legal Entity Even Needed to Establish a Presence in China?

25. Depending on a Company’s objectives, a legal presence in China may not be needed: • Licensing of technology and distribution of products can be achieved through transnational agreements between the foreign company and Chinese partners. • U.S. and Chinese service providers often can help manage a company’s market entry into China, often more cheaply and effectively than a company can manage market entry on its own, without the company having to establish a presence of its own in China.

26. Martin Lewin KALIK LEWIN 4720 Montgomery Lane Bethesda MD 20814 Tel: 240-744-7611 (Direct)Fax: 240-744-7601www.kaliklewin.com