Not sure why (the bad economy?) but we have been getting a rash of China joint venture deals and possible deals over the last six months or so, many of which involve a United States company wanting to enter into a Joint Venture with their China manufacturer so as to work jointly on manufacturing and marketing and selling some combined product or products around the world.
One of the mistaken assumptions we are finding the American company is making is that it can contribute existing China-based equipment to this sort of equity joint venture (EJV) and receive “credit” for doing so. Virtually every time, the American company is getting this wrong based on the bad advice of its putative Chinese joint venture partner.
Chinese law mandates that foreign companies doing equity joint ventures contribute a certain amount of capital to the joint venture. Then, the voting power of each joint venture partner is proportionate to the capital each partner put into the joint venture. Since the foreign partner usually wants to control the joint venture it must contribute more than 50% of the capital to the venture. Since manufacturing operations are usually quite expensive, this means that the U.S. partner must make a significant capital contribution.
To avoid having to come up with the typically very large capital contribution required the U.S. side has been telling us: “We know the capital amount is large. But don’t worry about it, we have that part covered.” When we ask what they mean and what they will contribute as capital to the joint venture, their reply is “the equipment and molds and tooling we purchased and then placed in the XYZ China factory and have been using for the past year. XYZ acknowledges that we own these items and that we can just contribute them to the joint venture at full value. So we have the capital contribution problem already solved.”
Unfortunately, this does not solve the problem at all because China’s rule on foreign contributions to a joint venture (the same is true with respect to WFOEs as well) is that the capital contribution must come into China from outside China for the China Joint Venture. Under Chinese law, it is very unlikely that the U.S. side has any ownership in equipment and tooling that is located in China. However, even if the U.S. side does actually own such items, they still cannot be contributed to the joint venture by the foreign partner because the foreign side of a China JV is not permitted to use RMB, cash, equipment and other goods, land or intellectual property that is located in China as its capital contribution to the JV. This is a black and white rule and there are no exceptions.
As we note above, the same rule applies to WFOEs in China. It takes an agonizingly long time to form a WFOE in China and we often get contacted by companies that have “jumped the gun” and started their China business operations before forming the WFOE. In doing that, they enter into leases and purchase equipment required for these operations. Consistently, they will want to contribute the lease payments and equipment (or the equipment costs) to the WFOE as a credit to the amount required for their capital contribution. For the same reasons discussed above, this is impossible because those contributions did not come into China from outside China for the WFOE.
For more on what it takes to succeed with a China joint venture, check out the following:
- How Not To Write A Joint Venture Agreement
- China Joint Ventures That Work
- Chinese Joint Ventures — The Information The Chinese Government Does Not Want You To Know
- Avoiding Mistakes in Chinese Joint Ventures
- Love The One You’re With. When China Joint Ventures Make Sense.
- China Joint Ventures. Who’s Your Partner?
- Joint Venture Jeopardy (article I wrote for the Wall Street Journal)
For more on what it takes to form a WFOE in China, check out the following: