While Shenzhen is becoming “Hollywood for Makers”, and not always in a good way, there don’t seem to be a lot of foreign open hardware/maker/start-up/accelerated/innovated/incubated people starting Chinese companies. As far as we know, we are the first foreign owned open hardware centric Chinese company in Shenzhen. With everything going on here, we definitely wont be the last.
There are three reasons foreigners start a Chinese company: to sell to China’s domestic market, to get legal residency, and to work with small suppliers who can’t accept foreign currency. We are only interested in the latter.
Working with a controlled currency
Chinese RMB is a controlled currency. Money only goes in and out of China for certain purposes, in allowed amounts, with the proper license. Most small Chinese suppliers don’t have an import/export license (and dodge taxes) so they can’t convert payments made in a foreign currency.
That’s why it is almost impossible for you, from abroad, to work with the small, flexible, inexpensive Chinese suppliers we have access to. If you really want to make small scale supply chain mash-ups, say 100 traffic-themed adult novelties, then tiny suppliers are crucial and they must be paid in RMB.
Our solution has always been to partner with a Chinese owned local company like Seeed Studio and FlyLin Consulting to handle our ground operation in China. Now we can pay small suppliers directly.
There are also tons of illegitimate Chinese and foreign agents in Shenzhen who do all kinds of exploitative things to circumvent the currency control system and bring money into the country. We now tell everyone: don’t work with someone in China until you see their import-export license!
Fight zombie lies
Before we continue, lets take a moment to address a pervasive, zombie myth that rings constantly at every start-up meet-up in town: a Hong Kong company is NOT an alternative to a Chinese company. Despite what agents and drunken foreign start-up groupies tell you, you’re not gonna be wiring RMB into China with your new HSBC Hong Kong account.
This is so obviously false and stupid on every level – if Hong Kong had exemption to the currency control wouldn’t every rich Chinese person setup a company to funnel money in and out? Yet everyone orbiting the start-up scene will proudly and confidently lay it out like they’re skilled insiders. Morons.
WOOF WOOF WFOE
Officially our company is a WFOE, a Wholly Foreign Owned Enterprise. A simpler, cheaper structure called a FIPE is becoming more common with young entrepreneurs, but we understand it to lack liability protection. Foreign Owned doesn’t refer to us, it actually refers to the Hong Kong holding company that owns the WFOE.
WFOE is a massive beast of a company. It files a full audit report every month, it must have a minimum size office, and every single penny of expense must have a government tax receipt (fapiao, above) attached.
Its a real company and its does have some cool advantages over an US-based LLC. We draw actual salary, and personal housing is a 100% tax deductible expense for the company. Profits can be remitted to Hong Kong as dividends and taxed as capital gains, if you’re into that kinda thing. While it may take a year to setup and cost as much as a small car, there are advantages if you actually live and work and run a company in China.
Hold me tight – start a holding company
You can own a WFOE personally, but it is seriously difficult to sell shares or take on partners, and there are massive tax issues.
Instead, open a Hong Kong company first, then the Hong Kong company starts the WFOE. There are certain tax benefits for remitting profits back to the Hong Kong company, but we haven’t done it and can’t comment yet. This is our structure, and we understand it to be the same structure Seeed is now using while preparing for IPO. Image source.
The Hong Kong company is quick and easy. Setup takes a week and costs around $700-$1000USD. Supposedly you can DIY, but we tried and eventually used an agent. Beware – the Hong Kong company requires an annual audit by a CPA ($500-$1000) and a registered secretary to file the annual report ($700).
Opening the Hong Kong company bank account is simple, but you’ll need an appointment and it will take 2-3 weeks to be approved. We use Hang Seng, but would prefer to have gone with HSBC cause, you know, they print the freaking Hong Kong money. It is helpful to take some invoices or contracts to prove you’re a real company. Monthly fees around $60.
The account can hold any currency, and you can exchange between almost any currency online, pretty cool. International wires are done online and cost about $35-$40USD.
Prove you understand basic tax principals
Hong Kong has a reputation as a tax haven. Sure, if you’re a legal resident personal taxes are pretty low, but that’s not much use to a foreigner with a small business.
Corporate tax is 16.5%, but your accountant won’t let you leave profit in the company so you’ll never pay corporate tax anyways! Same with Dangerous Prototypes’ US LLC, a pass-through entity isn’t even taxed! You’ll pay personal income tax in your country of residence, however much that is. Americans are also taxed on world wide income even when paying taxes as a legal resident of a foreign country. Get it?
If someone tells you about low tax Hong Kong companies just walk away, they’re a moron.
Choose your sleazebag agent
Agents are incompetent, sleazy, misinformed, and the absolute worst part of starting a Chinese company. There’s really very little opportunity to DIY a WFOE, so you’ll have to deal with them.
We interviewed 6 agents. Initially we hired the Chinese firm that did the Hong Kong company, but they hadn’t really done a WFOE before and the requirements are too numerous and fluid to leave it in the hands of an amateur. We fired them.
Next we hired a foreign guy who always seemed to have the answers we needed. He was super slimy and went on about having face (connections) and being the fastest in town, a total turn off, but he did seem to know the process.
Our agent misguided us multiple times, delaying the formation and costing money. The agent messed up really obvious and stupid stuff. We felt like he had never done a WFOE before either. Turns out, that was close to the truth. He subcontracted the paperwork to another local agent (Aaron Best), who actually presented at the first Hacker Camp…
Eventually we looked up the agent’s company registration. It isn’t even a WFOE. It appears he had two Chinese people start the company so he wouldn’t have to put up the 10 million RMB capital he registered. If you’re talking to an agent in Shenzhen, be sure to look up the company on the official SZ government business listing to confirm who you’re working with. Here’s our registration.
The agent said the company could be done in a month, but in all it took 4-5 months to complete this initial setup phase. Much of the delay was our own complicated situation because we’re an existing, functioning company. A competent agent would have foreseen and guided, instead ours made everything much, much worse. We paid the guy $7000, which includes lots of government fees.
Get your stuff together
Up until this year you needed 500,000RMB ($81,000USD) of actual cash to start a trading WFOE. There are no hard limits now, but you have to convince the government you can run your company for a year with that amount.
Everyone says minimum 100,000RMB if you want a work visa. Agents terrified us with likely untrue anecdotes about being deemed unfeasible, so we put up 400,000RMB fully paid. Supposedly this is enough to get 4-5 work permits for foreign hackers to work in our Shenzhen office, but who knows if that’s really true.
You need to prove that you have the full amount, but only 20% needs to be transferred up front. The remaining 80% can be paid over the next 2 years. At least that’s what they say, it seems really unfeasible for a small company because each payment takes weeks of processing documents and updating licenses.
A bank reference letter and a certified balance statement prove you have the capital. Hang Seng’s phone bank sent us to the nearest branch to apply in person, somewhat conveniently located in the bank district of a dusty little boarder town called Sheung Shui. The first Hong Kong metro stop outside China.
The banker insisted, INSISTED, there was no such thing as a bank reference letter OR certified balance statement. After 10 minutes of begging, they uncovered the form for the reference letter, but not the balance statement.
More begging and pleading, but they insisted that there was no such thing and threw us out. The next day the phone banker sent us the form by email to print and take to the branch. Got the same guy, but no apology for making us schlep back to Hong Kong a second time.
Both letters run about $50 each, and are available for pickup after 10 business days.
The director of the company needs to supply a passport. The passport will be out of reach for a reasonably long time, many months, so it is absolutely critical that you get a second valid passport if allowed in your country. It is quite easy in the US, all the Shenzhen regulars seem to have them.
The passport will need to be authenticated. The deal here is that China is not part of the Apostille Convention that defines how most countries translate and verify documents.
Authentication is a 1900s era flair of ribbons and wax stamps. The US State Department verifies the passport and makes a copy. The Chinese embassy in the US verifies the State Department copy with a ribbon. Back in China the government verifies the embassy ribbon with a wax stamp. Or something like that. $1000USD for this frilly anachronism.
Hong Kong company documents
All the Hong Kong company “green box” stuff needs to be authenticated by a lawyer (7000HKD/$1000USD). If you have a brand new Hong Kong company the documents are already authenticated, but ours was a year old and it all had to be redone.
Speaking of green box, we added a magnetic reed switch and RGB LEDs to ours. Nothing says “business” like a company box with a party mode to celebrate the signing (chopping) of a contract. So far bankers and lawyers don’t seem to find it as amusing as we do.
Expert tip: when signing documents in Hong Kong a copy of your entry visa slip is required. If you’re smart and have the second passport you MUST enter Hong Kong on the passport used to register the Hong Kong company. Our agent neglected to tell us about this, so we had to make two trips.
If the Hong Kong company is more than a year old China wants to see an audit report completed by a CPA. Hong Kong companies are required to file an audit report with the Hong Kong government every year anyways, but as a little perk the first is due after 18 months. Everybody knows this, all the agents use it as a selling point.
Dangerous Prototypes Limited (HK) fell into the gap – not old enough to need a report in HK, but old enough to need one in China. Instead of pointing this out and helping us deal with it, our idiot agent said our accountant had failed to file the report on time and we would have to pay fines and could even go to jail. He got us whipped up into a frothy lather and scared the hell out of us.
Nope, just needed to get the audit report done early. The audit took two weeks and cost about $500USD from a Chinese accounting firm with an office in Hong Kong. Submit a Google-translated Chinese copy of the report as well.
A WFOE office must be at least 30 square meters in commercial zoned space, not an apartment. Agents terrified us with myths about inspections, verification, losing visas, and bribing inspectors, so we were needlessly married to having a big office in Huaqiangbei.
We looked at a lot of offices in three buildings. SEG at the south, the Mr. Goodluck Buy building (not actual name) mid-market, and Galaxy Stars building at the North of the market. Offices run about 100RMB per square meter, plus building fees and tax.
The office is going to sit empty for half a year while the company is formed, so we wanted to pay about $1000USD per month (6000RMB). There were lots of too small offices in the 4000RMB range, and there were lots of really big multi-room offices for 10,000RMB+, but not a whole lot for us.
The Mr. Goodluck Buy building is unique. Its owned entirely by one company. That’s easier for a WFOE to work with, and there’s no charge for upgrading to a bigger office in the same building later.
We ended up in Galaxy Stars Plaza, the building at the very north end of the market with a helicopter landing pad. No, we haven’t been to the helipad. Yes, we’ve tried. Several times.
Galaxy Stars is the Chung King Mansion of Huaqiangbei offices, a Mos Eisley Cantina of little Chinese trading companies. Perfect place for us, and our logistics company is just a floor below.
Initially we had rental agents show us space, but they run you all around unable to get inside any of the offices. Its a joke. Asking the security guard on duty to show us around was much more effective. He found us a perfect 52 square meter office for 6000RMB/month including fees and taxes.
The contract needs to say that the owner allows the office to be used for a WFOE. Everyone exchanges ID copies, and they hand over a copy of the building tax license. The contract needs a realtor stamp to be official, the guard found someone to provide it.
China’s clean government
One theme throughout the formation process is that agents tell myths, stories, legends, “conventional wisdom”, and seemingly outright lie about stuff. One agent came into our office and said it wasn’t big enough, he was confident the work visa officer would review the floor plan and ask for a bribe. Image source.
Never, during this entire process, was there even a HINT of corruption in the Shenzhen government. Absolutely everything was by the books and squeaky clean. Follow the rules, file paperwork, wait, repeat. There wasn’t even a remote opportunity for something improper to happen.
Part of our motivation for writing this in such long form is to show how clean the experience was. The only corruption and incompetence we experienced was from agents.
The numbers man
An accounting firm is mandatory. The amount of paperwork they file monthly is epic.
China has two levels of sales tax/VAT. A small tax payer pays 3% VAT on everything purchased, and it cannot be refunded when things are exported or sold.
A general tax payer owes 17% VAT on everything they buy, but the tax is refunded when the stuff is exported out of China.
We have been both, currently we’re general tax payers and that was a horrible, horrible mistake. We haven’t done a VAT refund from exporting PCBs yet, it will be interesting to see what happens.
Accounting prices are the same all over town. 400RMB ($70USD) per month for a small tax payer, 1100RMB ($180USD) for a general tax payer. 50RMB ($9USD) per month per Chinese employee, and 150RMB ($29USD) per month per foreigner. Our accounting firm is acceptable, if a little lazy.
Got all that stuff now? It took us 3 months to get everything in order before filing the first document with the government.
Name check (2 weeks)
Submit a bunch of Chinese names, the government will pick their favorite. There are all sorts of naming rules. Ours shook out to Shenzhen Hanging from the Cliff’s Edge Electronics Technology Limited Company. “Hanging from the Cliff’s Edge” is the actual translation of Xuan Yaun, which is a close as we could get to “Dangerous”.
Foreign Ownership Certificate (4 weeks)
Here’s where that Foreign Owned part really clicks. The Hong Kong company applies to the government for permission to open a company in China. China gives us this giant certificate redeemable for one Chinese company. Now we’re getting somewhere.
Notice it says for investors from Hong Kong, Macau, and Taiwan? That’s because it belongs to the Hong Kong company, not us.
Business license (10 days)
All the documents and the company coupon go the local government. 10 days later we get a business license and a copy. These giant papers will have to be folded and carried a ridiculous number of places over the next several months.
We also get a half dozen permission letters from the local government. They want one every time we get permits, a bank account, visas, etc, etc.
The problem with stamps
So, China enjoys stamps. You need them endlessly. The company has three stamps: general stamp, financial stamp, and customs stamp.
KNOW IT: Domestic company stamps are round, WFOE stamps are oval. Are they really a WFOE? Check their stamp!
We each have name stamps as well. Literally just a stamp with English names.
During the next phase everyone needs the stamps: accountants, permit and licensing agents, visa agents, the bank. Of course you’re gonna need a little stamp time of your own too.
Here’s the rub: you only get one stamp and its illegal to copy them. Part of what takes so damn long with the WFOE is waiting for stamp time. For a while our stamps were couriered between 6 offices almost daily. This can’t be how Tencent deals, can it?
Mix and serve over ice
This is just the initial setup. To actually do anything with the company we still need a bank license and account (2 months), an import-export license (1 month), a work visa (3 months), and a couple other things. We’ll write these up in less-epic posts in the coming weeks.
Was it worth it? No idea yet. The dust is settling though, and we can see a day in the future when we’re running the company instead of starting it.