Ninety percent of problems when setting up business in China can be avoided by the deployment of due diligence at the front end of the investment planning. Here we point out some of the areas that can hinder a sensible approach to due diligence, the hidden risks and basic checks. The process does not have to be expensive.

Chinese business licenses

You should ask for a copy. It will list (in Chinese) details of the legally responsible person, the registered address, the amount of registered capital (which is also the limited liability) and the period of the license. It will also detail whether the company is a limited liability company or a privately owned, non-limited liability company. This basic information should be checked off against what you know. If there are any discrepancies, ask the reasons why. It is relatively common for the actual legally responsible person to not even be the person you're dealing with. This especially applies to trade fairs such as the China Import and Export Fair (Canton Fair), where it is estimated 90 percent of the exhibitors are middlemen and not the factory itself. Finding out whether a person is a middleman or represents the factory directly has its advantages:

- If you can deal with the factory directly, prices will be significantly lower; it is not uncommon for markups of over 100 percent to be made by Chinese middlemen.

- If you can verify the business license as being from a factory, you have more security of knowing the legally responsible person, the address of the premises and the registered capital; your purchasing is backed by a legitimate business, not just a salesman taking a cut.

The Chinese limited liability status

A commonly misunderstood area by foreign investors when assessing the creditworthiness of a Chinese business is the aspect of "limited liability status." Usually, in the West, this is issued in the form of a cash injection into the business, and can be checked via the public record office. Extending credit then, say of $1 million, to a company with a limited liability of just $25,000 may then start to flag up red with your accounts department. It's a good way of protecting yourself against providing over-credit to customers more likely to default, and also a proven method of assessing risk when providing credit in the form of cash or sales.

In China, however, there is very limited access to any public records, and those China business licenses that state "the amount of registered capital" are prone to inaccuracies as well. As is always the case in China, the devil is in the details.

The registered capital amount as displayed on a Chinese business license also fulfills the same criteria as the limited liability status. So if a business has 1 million yuan as its registered capital, the shareholders are also responsible for that amount of liability. If you want to send product worth $1 million to a Chinese company, you'd better start assessing the amount of risk in the published registered capital amount shown on the license.

But it doesn't stop there. When setting up a Chinese domestic company, before applying for the business license, the investors are required to contribute the registered capital required. Accordingly, a further check is needed to verify the registered capital amount was in fact paid. This document, a capital verification report, has to be issued by a third party Chinese certified public accountant (CPA) firm cross checking bank statements showing the amount was injected. The false production of such a certificate means the CPA firm can also be liable for fraud.

If a capital verification report has been issued, then the business has a legal limited liability status and it was, at time of incorporation, capitalized in accordance with the law.

It's these simple checks that can separate a good sale to China from a delinquent sale to China, and they are easy to carry out.

Mergers and acquisitions: joint ventures

A joint venture (JV) in China is a type of investment that creates a legal entity owned by the partners based on pre-defined terms. The regulatory regime over ownership and the equity varies according to the type of JV, but essentially it is common for the foreign investor to contribute cash, and the Chinese land and buildings as part of the deal.