One of the most important aspects in a business relationship is trust. In order to gain that trust, partners must know each other well. However, at the beginning of this process a thorough due diligence is key to achieve a successful business association.
When doing business with a Chinese supplier, due diligence is a must. Many international corporations view the lack of transparency as one of the main obstacles to invest in China more aggressively.
Foreign enterprises and foreign-invested companies need law-complying and reputable business partners in China. According to Transparency International’s Corruption Perceptions Index 2023, China ranks 65th out of 198 countries.
Due diligence is the process necessary to confirm that all the information provided by a company is correct and true. This is common practice when entering into an agreement with a third party.
The substance and completeness of the investigation are determined by the nature, complexity, and magnitude of the transaction.
In China, foreign enterprises working with local suppliers often encounter unexpected difficulties. The US Commercial Service recommends that international corporations perform a more extensive due diligence in China.
Compliance is especially necessary for foreign companies operating in China because they may be targeted by local authorities for more audits and evaluations.
Though the business environment in China has improved in the past few years, it is still difficult to obtain all the necessary information. Since most of the paperwork is in Chinese and the Chinese counterpart does not always understand English, companies may face significant linguistic obstacles.
Foreign companies which want to or have established partnerships with Chinese suppliers must perform extensive reputational due diligence on their business partners, which includes an examination of open-source materials available online and in the media.
This process is especially important to protect the integrity and reputation of your firm and avoid becoming unintentionally involved in the web of bribery and corruption, to lessen the possibility of becoming a target of the government’s anti-corruption efforts and instill greater trust and confidence in current and prospective local business partners.
Unfortunately, it is not uncommon for foreign companies to end up deceived by their Chinese suppliers, who may not deliver items upon purchase or deliver subpar goods. Companies may also be victim of internet fraudsters disguised as suppliers.
There are two types of due diligence:
Due diligence requiring no cooperation from the Chinese company, that is, you can obtain relevant information from public sources and due diligence requiring cooperation, that is, you need the Chinese company to provide you with certain information. With the legal Chinese name of your supplier, you can get plenty of information from legal and public channels. The focus of supplier due diligence depends on the purposes of the investigation. Many parties are particularly interested in the legal compliance of Chinese suppliers, especially anti-corruption compliance, including any record of administrative penalties or litigation involving the suppliers and their executives, shareholders, and actual controllers. In other cases, the investigating party may want to concentrate more in the supplier's background and credentials, such as the supplier's shareholding structure, beneficial owner, financial statements, solvency, business situation and market reputation. Some companies are interested in export control and sustainability and may want to find out more about their suppliers' raw material origins, labor rights protection, corporate governance, and environmental compliance.
Due diligence on suppliers can be conducted either "back-to-back", where suppliers are not informed, or "forthright" where suppliers are asked to provide needed information, or a combination of both. The "back-to-back" approach typically relies on public sources, while the "forthright" approach requires suppliers to fill out questionnaires, submit materials and attend interviews.
Due diligence can be conducted through online and offline searches and interviews, and materials provided by suppliers. It is also common to cross-check the findings through on-site visits and third-party interviews for important matters.
In China, there is access to a large amount of valuable public information through various sources, including government websites and web search engines.
With the Chinese supplier’s legal name, you can verify whether the company actually exists and what is its status: existence, in business, moving-in, moving-out, closure, cancellation, suspension, and liquidation. The first four states indicate that the company is in normal operation.
Larger Chinese companies generally operate at their registered address, whereas many small companies would not. You can find the actual business address in addition to the registered address through public marketing materials and sales records.
Shareholders of Chinese companies need to disclose their subscribed registered capital. The paid-in registered capital reflects the size of the company’s assets. For most companies, the paid-in contribution accounts for only part of the subscribed contribution. However, in the case of factories, the proportion of paid-in contribution will be comparatively higher, because it needs such capital to buy necessary fixed assets such as equipment and plants.
If a factory doesn’t have much paid-in capital, you have a good reason to doubt it as a shell company.
For non-public companies, unless they choose to, their financial information (including management accounts, audit reports, books, and records), internal resolution documents and business transaction information are generally trade secrets and not publicly available.
Language and cultural barriers are the main obstacles that a foreign company faces when investigating a Chinese supplier. Lack of access to information, inability to determine the truthfulness and completeness of information, and challenges in assessing the risks at practical level may represent additional issues.
Companies should seek the advice of an experienced advisor, with international vision and local wisdom. A team of local attorneys proficient in English and versed in local law can help request information and identify issues more cost-effectively.
To learn more about our services in China, contact our Head of Business Advisory - Ms. Kristina Koehler-Coluccia at email@example.com. DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.