Lack of proper due diligence in China and transparency have been crucial reasons for international corporations deciding to invest more aggressively in China, while also limiting the participation of Chinese enterprises outside. According to Transparency International’s Corruption Perceptions Index 2019, China ranks 80th out of 198 countries.
Furthermore, a Transparency International study of emerging market multinationals in October 2013 found that Chinese corporations are more likely to be involved in corruption than their counterparts in other BRICS countries (Brazil, Russia, India, and South Africa).
What is Due Diligence?
Due diligence entails studying a company, potential investment, product, or personnel to confirm all information offered by the opponent is true. It is frequently carried out before 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.
Due diligence can be performed internally, such as when hiring new employees, or externally, such as when doing business with another company. This article will concentrate on external due diligence.
Another distinction in due diligence, particularly in Mergers and Acquisitions, is between hard and soft due diligence. Mathematics drives hard due diligence, which focuses on measuring organizational data. Soft due diligence, on the other side, collects information on “human capital,” such as business culture, employee motivations, and relationships. Conducting both types of due diligence is critical for a successful merger and acquisition.
Why is due diligence on Chinese company so important?
In general, due diligence allows you to know exactly who or what you’re dealing with before concluding a business deal. As a result, it safeguards your firm from a variety of threats.
More precisely, when doing business in China, many organizations face challenges or unforeseen problems. The US Commercial Service recommends that international enterprises perform more due diligence in China than they would in other areas. Foreign firms may also feel more targeted by audits and evaluations, which strengthens the demand for compliance.
Be aware that, while the business environment for China company checks has improved, it is still difficult to obtain all of the information you require. Laws and regulations are frequently ambiguous and change on a regular basis. Furthermore, because the majority of the paperwork is in Chinese and the Chinese counterpart does not necessarily understand English, you may confront significant linguistic obstacles. As a result, you should consider contacting professionals who can assist you with this procedure.
Reasons to be cautious
Foreign companies who want to or have established partnerships with Chinese companies must perform extensive reputational due diligence in China – on their business partners, which includes an examination of open-source materials available online and in the media. This is especially true for the reasons listed below:
- To protect their integrity and reputation 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.
- To instill greater trust and confidence in current and prospective local business partners.
Due diligence on Chinese company: External
External fraud, on the other hand, occurs outside of the company and is committed by other parties. Such an example is when providers take advantage of forgiving customers.
Indeed, it is not commonplace for international businesses to be duped by their Chinese suppliers, such as non-delivery of items upon purchase, delivery of subpar goods, or internet fraud by fraudsters disguised as suppliers.
However, there are numerous ways for a corporation to decrease its exposure to external fraud. They can, for example, conduct a discrete investigation of the prospective supplier, which may include a check of the Administration for Industry and Commerce (AIC) firm records, a verification of the business’s financial performance, and request references from existing customers.
It is also advisable to see the possible supplier in person and tour the supplier’s factory before signing a contract, or to nominate a trusted person or third-party agent to do so on your behalf.
Finally, it is always advised to begin with a minor purchase order to limit financial risk in the event of fraud, as well as to sign a strong supplier contract outlining the supplier’s obligations as well as the client’s rights and reparations in the event of contract breach. Through the contractual connection, the company’s code of ethics should likewise be imposed on suppliers.
It is also recommended to conduct similar due diligence on Chinese company(s), such as prospective distributors or joint venture partners (JV).
How to Conduct Due Diligence on Chinese company(s)?
Due diligence is a broad initiative, and the questions you should ask will differ based on the nature of your company check in China. However, you will find a list of some factors to consider before closing a trade below.
Registration examination
First and foremost, you must ensure that you are working with a legitimate organization. This implies that the Chinese firm must be registered with the State Administration of Industry and Commerce (SAIC) or a local AIC. This information is available on the website of the People’s Republic of China’s Administration for Industry and Commerce. You will be able to verify information such as the registered capital, the registered legal person, the scope of operation, the registered address, and the validity of the business license there.
Financial examination
Conduct the following due diligence on Chinese company(counterpart) if it is a listed company:
- The capital structure
- Percentage of Shares
- The primary stockholders
- The ratio of capital availability
- Investing Options
- Statements from banks, loans, and credits
- Grants from the government
- Subsidies
- Others’ debt records
Accountancy examination
It is recommended that you obtain 3 to 5 years of historical records from your Chinese counterpart. You should especially double-check the accuracy of the following information:
- Receivables
- Invested capital
- Other liabilities and payables
- Using the Chinese Accounting Standard (e.g. accounting on an accrual basis)
- Income and expenses
- Documents supporting permitted payments
- Invoice authenticity
Tax examination
You should also assess if the company: benefits from advantageous tax rates; is in compliance with foreign exchange restrictions; and is in compliance with tax legislation regarding tax filing.
Take care: If a corporation refuses to show you the necessary papers, you should reconsider concluding the purchase. Most genuine businesses will not restrict access to such documents. If the Chinese company verification provides you with the material, you should have a specialist analyze it to ensure the documentation is true.
Operational examination
- On-site visits: After reviewing the relevant papers, you should visit the company in person to confirm the information. Examine the premises, stocks, and production area (if any) and speak with staff. Interview lower-level employees who may be more willing to give relevant information than senior supervisors.
- References: Reputable businesses will gladly provide references for due diligence purposes. Clients, suppliers, partners, and competitors are examples of these. The more references you have on the Chinese company, the lower your risk will be. You will be able to discover their relationships, quality, payments, the number of consumers, and much more by calling these references. This will assist you in assessing your Chinese rival.
Best practices for due diligence on Chinese Company
1. There should be no assumptions
By establishing any assumptions with possible business partners, you put your company in danger. Even while the vast majority of Chinese companies desire to do the right thing, rigorous due diligence will help weed out problematic cases. Even for well-vetted partners, due diligence on Chinese company(s) can provide valuable information for your discussions and strategy.
2. Both pre-due diligence and post-due diligence are essential.
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, and you must be prepared. Maintain continuous due diligence as an essential component of your business.
3. Check the email address and English-language website
It is typical for Chinese business people to utilize public domain email addresses (e.g., sina.com, 163. com) rather than enterprise email addresses. While a public email address should not be an automatic red flag, further work should be done to check your possible business partner’s identity and claims. Also, if a corporation only provides an English version of its website, it could be a phishing hoax.
4. An on-site inspection is beneficial
Because of the distance, it is tough to learn about your partner’s past, capabilities, credibility, and performance. On-site inspection or on-the-ground presence is critical for large deals.
5. Top-down communication of basic organizational principles
Local management must instill a compliance culture so that the tone from the top, as appreciated by outside stakeholders, is effectively transmitted to personnel operating in the China office. Compliance and work ethics should be incorporated as KPIs for local managers, alongside those for the Chinese subsidiary’s financial performance.
Furthermore, local managers should be trained not just on local legislation but also on international compliance rules that the foreign headquarters must follow. This allows them to comprehend the significance of economic crimes committed in China for the business as a whole. With the Chinese management team monitoring and promoting compliance with fraud prevention programs, overseas shareholders should be able to mitigate their business risks there more effectively.
6. Spend pennies to save money
You can begin the due diligence on Chinese company(s)/suppliers by performing some preliminary checks using your own network and knowledge. However, given the complexities of the Chinese market and the difficulty in obtaining information, you may require the services of a professional service provider to do due diligence or quality control on your behalf. When compared to the possible losses from poor due diligence, paying upfront can be a worthwhile investment.
7. Quality assurance and quality control
The key to successful Chinese supplier sourcing is to reduce faults and receive products that fulfill your specifications. Due diligence on Chinese company(counterparts) must continue even after you have reached an agreement to guarantee effective quality control. Request qualification credentials and samples ahead of time. Recognize that faultless samples do not imply flawless mass production. Obtain and speak with recommendations from your partner. If a supplier promises an extremely low price in comparison to others, be confident that the quality will be unacceptable. It is critical to have your own quality control inspector in the plant who examines production on a regular basis. If the products are defective, include specified penalty conditions on your purchase orders.
Furthermore, you should:
- ensure that your product design is manufacturing-friendly;
- audit and approve factories using a relevant checklist;
- obtain the manufacturer’s approval of the quality control plan;
- write down detailed product specifications;
- perform quality control at several points of mass production;
- follow up with a corrective/preventive action plan when necessary;
- and revisit product specifications.
8. In terms of the authenticity of corporate seals
Firm seals (also known as chops) are important components in governing a company in China. All lawfully registered firms in China must apply to the local Public Security Bureau for official company chops (PSB). The PSB will retain specimen samples in the event of a future dispute or fraud verification. All formal papers, including contracts, memos, bank account applications, labor contracts, and so on, use the business chop. It has a circular form. Aside from the official corporate chop, there are also financial chops, contract chops, and legal representative chops. In China, it is critical to confirm that the chop is real and being used in an allowed manner by an authorized party.
You should go to the corporation or the local authorities and ask if the person holding the seal is authorized to sign and stamp the documents in question. Because local governments rarely reveal their files to private citizens, you can employ a local service provider, a licensed lawyer, or a due diligence firm to conduct an investigation on your behalf.
Due Diligence on Chinese Company – Checklist
Due diligence is vital to protect oneself regardless of where you are on the globe or who you are about to do business with. Things can be a little more difficult for due diligence in China due to language barriers and limited access to information, but they are not impossible. Here is a list of tasks to complete:
1. Request a copy of the company’s business license, which contains the most essential information about the company: Official company name, date of creation, business scope, and owner’s name.
2. If feasible, confirm the legality of the business details you’ve been given with the local State Administration for Industry and Commerce (SAIC).
3. The following points should be noted on the license: Is the business scope appropriate for the type of business you intend to conduct? Is the registered capital appropriate for the business you intend to run: A consulting firm may have as little as 100,000 RMB in registered capital, but a manufacturing firm may have several million RMB.
4. Who is the individual with whom you are conversing? Is he using a work or personal email? While it is very uncommon for genuine persons to use personal email addresses such as xxx@126.com or xxx@shou.com, you should be wary of who they actually are. Think about whether you’re dealing with an official corporate representative or a middleman/broker. Does my contact have legally binding jurisdiction over the company?
5. Examine the company’s website. Compare the information accessible on their English site to that available on their Chinese language site, noting any inconsistencies. Check to see that the company’s location matches the registration address. If not, it’s worthwhile to ask a few additional questions.
6. Is the payment to be made to a personal bank account in someone’s name or to the official Company account in the company’s name? China company checks often utilize personal accounts in order to reduce taxes, as well as requesting the bank details of the company as an additional method of verifying legality. Furthermore, all Chinese companies should be able to provide you with an official invoice issued by the Tax Administration (not one printed on company letterhead); if they are unable to do so, it is for one of two reasons: they are mitigating tax (in which case you may negotiate) or they are unable to do so because they are not tax registered.
7. Is there a quality control system in place with a manufacturer? Is there worldwide quality certification? If this is the case, request a copy and check with the permission organization. It is also worthwhile to compare the company to:
- The International Suppliers Blacklist
- Trademark Office of the SAIC
- State Intellectual Property Office
8. Depending on the value of your transaction, consider employing an organization to visit your china suppliers for due diligence purposes. Typically, 30% is accepted as a retainer, with the remainder, 70%, with the B/L. Consider other payment methods, such as a letter of credit, to reduce risk. In the event of a dispute, a written arbitration procedure (either in China or elsewhere) rather than the Chinese courts is always preferable: it will save you a lot of money and time.
9. Finally, consider meeting and banquet time as part of the process. You may think this is time-consuming, but the Chinese are using it to determine whether you will be a suitable and trustworthy partner and whether they want to embark on a long-term commercial partnership with you. It is prudent to follow suit.
While the reality of conducting business in China may appear intimidating, they are not unsolvable. Make no assumptions, but do want facts and proof. Again, if you’re not sure about something, ask and always trust your instincts.
Frequently Asked Questions
Ques: How do I complain about a Chinese supplier?
It is possible to file a complaint with the Chinese Embassy or Consulate in your country. Occasionally, the embassy or consulate will refer your complaints to law enforcement agencies and trade promotion agencies in China, who can mediate your dispute with the Chinese supplier.
Ques: How to verify the Chinese business license?
Every company legally incorporated in China has a business license. It is an official document issued by the State Administration of Industry and Commerce (SAIC) and acts as the company’s identification and verification. The SAIC or the local AIC (where the company is registered) websites provide information about a company’s business license, but more importantly, the local AIC branch can also provide this information. Only preliminary information from websites can be trusted; it needs to be supported by other verification methods.
Ques: What are frequent scams or mistakes by Chinese suppliers?
It is not unusual for scams to occur in China, but the distance from your home country, the impenetrable language, and the vastly different culture can make even the most shrewd business person susceptible to fraud.
The main scam warning signs are:
- An unsolicited request.
- Goods being sold far below market value.
- Payment into an unknown bank account.
- Payment of facilitation fees, unknown taxes, gifts, etc.
