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Foreign companies face unique due diligence challenges in China

Prevention and preparation are fundamental for any foreign company looking to do business in or with China. Due diligence is a prerequisite for any transaction with Chinese parties and failing to do it properly, or making unsubstantiated assumptions about potential partners, will put your business at risk.  

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Operating in the Chinese market can be very lucrative but comes attached to unique risks and requirements. Due diligence can provide additional intelligence for your negotiations and China strategy, however Foreign companies face unique due diligence challenges in China.


Due to the limited open channels for accessing information in China, any foreign investor looking to set up business will require a professional service provider to conduct comprehensive due diligence on potential business partners, agents, or suppliers.  


Due diligence is all about investigating a company, potential investment, product, or staff to confirm all facts that have been provided by the counterpart. It is usually conducted before entering into an agreement with a third-party.  


Corporate ‘Due Diligence’ is permitted in China and is standard practice. This includes legal, financial, and operational due diligence and is intended to establish whether the target company is in legal, tax and financial compliance.   


It is a common procedure – both to ensure tax returns are accurate, audits are correct, and for larger businesses, compliance with pending IPO listings. Chinese authorities encourage foreign investors to be in compliance and to be self-governing.  


China’s Growing Risks 


China presents unique challenges for foreign companies. As foreign businesses adapt their strategies in the country, it is important to be aware of the changing landscape.  


The current economic and political situation in China is pushing some foreign companies to leave the country or minimize their footprint. This, in return, is causing tension with authorities and putting pressure on companies. 


In general, due diligence enables you to know exactly who or what you are dealing with before closing an important deal. Therefore, it may protect your company from many risks. 


Many companies are facing difficulties or unexpected problems when doing business in China. The United States Commercial Service particularly advises conducting more due diligence in China than foreign companies would usually need in other markets. Foreign companies may also feel particularly targeted by audits and reviews, which reinforces the case for compliance. 


Even though the business environment has improved in China, it is still difficult to get all the necessary information. Laws and regulations are often unclear, and they change regularly. Additionally, as most of the documents are in Chinese and the Chinese counterpart does not necessarily speak English, there may be huge language barriers.  


Many companies are fooled by people they know. A common situation is where a foreign company pays someone to register a company or IP in China (or elsewhere) but nothing ever gets filed.  


There are fake law firms that collect money from foreign companies to register their IP or their company; pocket the money and do nothing. These fraudulent entities exploit those without international experience, cashing payments but never delivering services. They mirror unscrupulous manufacturers that escape with client money without providing goods.  


The Importance of Due Diligence 


Conducting due diligence in China is currently possible for foreign companies, however it is becoming more difficult. This new level of difficulty could result in more companies choosing to opt out of conducting due diligence in China.  


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This, in turn, could lead to an increased level of risk for companies doing business with Chinese firms. Despite these difficulties, it is necessary to work within the restrictions and ensure that due diligence is conducted legally and ethically, especially with the elevated levels of risk currently associated with China.   


Verifying international entity and intellectual property registrations is quick, simple, and affordable. Companies should do this on a regular basis. 


Due diligence is a continuous process. It is important to use caution during your time in the market. Trusted partners now may be less reliable tomorrow. Maintaining continuous due diligence as an essential component of a China operation.  


Due Diligence Checklist 


Conducting the necessary due diligence can help avoid costly missteps. The following are important items to check: 


  • Verify registration documents for overseas entities directly with government sources 

  • Conduct background checks on potential partners and key employees 

  • Confirm intellectual property registrations are properly filed and owned by your company 

  • Review all contracts and agreements in detail with experienced international counsel 

  • Inspect facilities, operations, and inventory of entities you plan to acquire 

  • Analyze financial statements and tax filings going back several years 

  • Interview current distributors and sales channels to assess relationships 

  • Search court records for pending litigation involving target entities 

  • Confirm required business licenses, regulatory approvals, and certifications 

  • Review corporate records and documents for any modifications or irregularities 

  • Confirm bank accounts are properly registered and owned 

 

Foreign investors should be aware of China’s laws and the boundaries of their scope of business. Not being in compliance with those attracts problems, as does deliberately attempting to blur the lines of permissible due diligence. 


Foreign companies can significantly improve their chances of success in China by prioritizing due diligence and securing assets in advance. Being pro-active and staying informed with current laws and regulations can prevent making serious business mistakes.  


Companies should regularly evaluate their China strategy and stay vigilant on sudden changes. Before making any major moves, it is crucial to safeguard your company’s interests. 


 

Woodburn Accountants & Advisors is one of China’s most trusted business setup advisory firms.


Woodburn Accountants & Advisors is specialized in inbound investment to China and Hong Kong. We focus on eliminating the complexities of corporate services and compliance administration. We help clients with services ranging from trademark registration and company incorporation to the full outsourcing solution for accounting, tax, and human resource services. Our advisory services can be tailor-made based on the companies’ objectives, goals and needs which vary depending on the stage they are at on their journey.

 

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