When setting up a new business in China, speed kills. Things take longer to accomplish in China, particularly at the start up phase. U.S. companies are notoriously impatient and will often attempt to speed up the process, which generally leads to disaster. For success in China, you need to expect that everything you plan to do will take longer than expected. If meetings in the U.S. or Europe require three days, plan on three weeks of meetings in China. Any attempt to rush the process will lead to disaster. While this message has generally been accepted by foreign investors in here, I am now seeing a related issue that is very dangerous for foreign investors in China.

I work a lot in establishing WFOE and JV companies in China. Formation of such entities takes much longer in China than in Europe or the U.S. The process can take a particularly long time for newcomers to China who are unwilling to provide all of the detailed documentation required by the Chinese authorities company approval. In many cases, as the approval process drags on for many months, the foreign investor grows increasingly impatient as it watches business opportunities pass by while waiting for government approvals. This frustration is compounded by the desire of the Chinese JV partners, employees and suppliers to begin earning income as soon as possible.

In response to this frustration, there is a strong temptation to transmit funds early and start business before the WFOE or JV company has been formally approved. This is a disastrous decision and should be avoided at all costs. I see this in a number of settings, but there are two common scenarios:

1.The first common scenario involves forming a WFOE by a foreign investor. The approval process is extending far longer than expected. The investor is approached by a potential customer for work that must be done immediately. Unable to resist the temptation, even though approval to do business has not been obtained, the investor leases space, hires contract employees and begins work in China. The foreign investor never mentions this to their lawyer or accountant in China. When the approval for the WFOE is finally received, the investor is required to contribute its capital contribution in cash to the bank account of the WFOE. At this time, the investor will say: We do not have enough cash to make the full capital contribution because we have already spent a substantial portion of our proposed initial capital operating (illegally) in China prior to receipt of approval.

The investor generally believes that all of this pre-incorporation expense can be taken as a credit against the amount of their capital contribution. This is wrong. All of the money spent operating (illegally) prior to company approval is simply ignored by the Chinese authorities. The foreign investor is then in the difficult situation of (1) being forced to obtain additional funds to enable it to make its full capital contribution and (2) obtaining no credit whatsoever for the pre-incorporation expenses in terms of capitalization or cost deductions for the new company. In effect, the funds expended prior to incorporation are simply wasted.

2.A U.S. company is entering into a JV company project with a Chinese company. In many cases, the Chinese partner has a strong need for an immediate capital infusion. This strong need for capital immediately is often the primary reason the Chinese side is seeking to form joint venture. As with the investor in the WFOE, the Chinese side will often grow impatient and will convince the foreign investor to transfer its capital contribution prior to approval of formation of the joint venture company. This is a mistake. Capital contributions to a joint venture company must be made directly to the bank account of the joint venture company. This bank account can only be opened after the joint venture company has been approved. Funds send to China prior to that time simply to not constitute capital contributions. Often, if the funds are sent early, the funds must be returned to the foreign country and retransmitted after the joint venture company has been formed.

Any even more dangerous situation is one where the funds are actually used by the joint venture partner for infrastructure improvements that are completed prior to the approval of the joint venture company. It is very common for me to be contacted by a U.S. and a Chinese company to form a joint venture. When we come to the discussion of the capital contribution, the parties explain: The U.S. side has already provided funds to the Chinese partner. The Chinese partner has used the funds to build the factory that will now house the joint venture company. The U.S. side then requests that the amount already given to the Chinese partner be treated as its capital contribution to the joint venture company. I then have to explain that the funds contributed cannot be treated as a capital contribution. What the foreign investor has done is make an undocumented and unsecured loan to the Chinese partner. The U.S. side must still contribute cash to the joint venture in the amount of its proposed capital contribution, with no credit for the funds already contributed. This of course is a major problem that is often impossible to remedy.

In both these scenarios, foreign investors greet the news that they have thrown their money away with shock and disbelief. Speed kills. Just say no.