A joint venture (JV), like a WFOE, is also a limited liability company in China, but differs in that it is owned by both foreign and Chinese investor(s). The percentage owned by each of the investors varies depending on what is agreed upon between the investors in the JV. Once established, the JV becomes a separate legal entity in which the liabilities of the investors are limited to their respective capital contributions, and generally does not extend to the investing parent companies or individuals.
JVs were the most common foreign investment structure in China in the late 1980s and 1990s as the doors were gradually opened up to foreign investment. This is mainly because obtaining approval for a WFOE was difficult then since 100 per cent foreign-owned entities were highly discouraged by the Chinese government as they were considered opposed to the preference and practice of foreign investors cooperating with Chinese partners.
However, as other investment structures such as the WFOE became available and more widely used as a result of China’s obligations for World Trade Organization (WTO) accession and membership in 2001, JVs have become increasingly unpopular amongst foreign companies doing business in China. This is mainly due to the many misunderstandings and disputes typically arising between foreign and Chinese parties to JVs over such things as management control, technology transfer, and intellectual property (IP) theft. Inheriting partner liabilities and having to split the profits are also important reasons why JVs have gradually fallen out of favor.
Despite the disadvantages, however, there are numerous reasons why setting up a JV rather than a WFOE or representative office may be the best option for some foreign investors entering the Chinese market. Firstly, it may be one of the only options. According to China’s Negative Lists, foreign companies and individuals can only invest via a JV in certain industry sectors that are categorized as “restricted” for foreign investment (i.e., they cannot invest via a WFOE).
Secondly, in both unrestricted and restricted sectors a JV may be of strategic importance. For example, the support of a local Chinese partner can assist with initial operations, help the foreign investor to gain knowledge on the local market and business environment, and establish and maintain guanxi (“relationships” or “connections”) with local governments to secure approvals, benefits and opportunities. Furthermore, the foreign investor can leverage the sales channels, network, facilities, land-use rights, workforce and other resources of the Chinese partner, who can also help with expanding the business into different local markets.
A third reason why a JV is often attractive is that the Chinese tend to be better at lowering costs than their foreign counterparts, which is important when competing with other Chinese companies for local market share. Finally, a foreign investor may decide to establish a JV because they are under financial pressure due to global developments and because of easy access to capital (which is often more readily available in China these days than in foreign countries) from Chinese companies with abundant cash and resources.
For foreign investors looking to enter a JV with a Chinese partner, an in-depth analysis of the reasons for doing so and the business model and strategy of the investor(s) is required, in order to determine if it is the best choice, and if so, to provide proper guidance in the setting up process.