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- How to be eligible for the treaty benefits for China-sourced passive income under the New Rules?
- China Waives Work Permits for Hong Kong, Taiwan and Macau Residents
- OLN Ranked by Benchmark Litigation 2018
- Launching a Startup in Hong Kong? These are the Legal Issues You Need to Know
- Buying A Chinese Company? Why China Deals DON’T Get Done.
Items filtered by date: June 2018
Benchmark Litigation Asia-Pacific has announced that OLN is ranked as a Recommended Firm of 2018.
This is excellent news for the firm, as we are ranked for the first year of Benchmark Litigation arriving in Asia-Pacific.
Congratulations to our following Practice Areas:
Commercial and Transactions - Tier 3
About Benchmark Litigation
Benchamark Litigation was first published in 2008 covering the litigation and disputes markets in United States and Canada and has broadened its coverage to include Asia - Pacific this year.
To succeed with your startup, you have to find ways to monetize your ideas that comply with the law and use the law to protect your business, all without letting it become a distraction.
Here are five startup law issues that you need to know about, at least at some level:
1. Business Formation
There are many reasons you should form a business entity for your startup rather than operate as a sole proprietorship. In Hong Kong, in most instances, that will mean a limited company. Limited companies can protect the founders and investors from corporate liability, own property, open bank accounts, have different types of shareholders (holding common and preferred shares), sue and be sued, and carry on business both in and outside of Hong Kong.
It is important to form your company early and to document the formation, the ownership, and the agreed arrangements among the shareholders. All of this can be done cheaply by professional corporate service providers but if you want to make sure that it is done properly, taking into account the current and future needs of the business, as well as the preferences of the founders (and investors), you should speak to a startup lawyer first.
2. Intellectual Property & Confidentiality
As a startup, your most valuable asset will likely be your intellectual property Trademarks protect your name and branding, trade secrets protect certain kinds of confidential business information, and patents protect any inventions your startup will use. All of these require registration to enjoy protection from outsiders. Copyrights protect creative works such as songs, literary works and computer code but are automatically protected and normally do not need to be registered.
If you like most startups, you will also need to design a website and register a domain name for it. Like the other intellectual property created for the startup, steps will need to be taken to transfer ownership of your domain name to the startup itself and you will need to seek advice from a startup lawyer on this.
There is no one-size-fits-all time for registering IP but as a rule, before settling on a name for the startup, you should have a trademark search and companies search carried out to ensure that no one else is already using the name.
To avoid disputes and ensure everyone knows what their role and responsibilities are, you will need suitable written agreements in place with all of your co-founders, employees, and contractors, that make it expressly clear that the startup owns all IP and not the individual creating the IP. In addition, you should have a standard non-disclosure agreement (“NDA”) for third parties to sign that prohibits them from disclosing and/or using your confidential information.
3. Securities Law
Although crowdfunding laws in the US may eventually evolve to the point that it is relatively easy to approach investors funding, here in Hong Kong, there are longstanding legal restrictions on raising capital from “members of the public” and these can make it illegal for you to approach potential investors for funding. However, there are exceptions that allow startups to raise money without breaking the law.
You should know that the most popular and useful exceptions require you to only raise money on a private placement basis or from professional investors (a narrowly defined group of individuals). You should always speak to a startup lawyer before raising money for your startup, even if you are just raising money from family and friends. This can avoid unrealistic expectations on the part of investors and unwittingly tying an unrealistically low valuation to the startup.
4. Employment Law & Commercial Law
Employees and contractors are treated differently under the law, with employees given greater protection.
Before engaging individuals and/or vendors to perform services for your company (eg: app developers), you need to speak to a startup lawyer about what they are going to do, who is responsible for what, how they will be remunerated and, most importantly, who will own any IP they might create in the process. You can then work with your startup lawyer to create a suitable agreement to govern the relationship. In all likelihood the startup will only need a few of these to begin with.
5. Contract Law
Wherever possible, you should use written contracts when dealing with third parties. Oral agreements are normally enforceable in Hong Kong but proving what was agreed on can be complicated (read: expensive).
If limited time or resources prevent you from preparing written contracts, send out a binding letter of intent or, at the very least, a follow up email and send it to all everyone concerned to document the key terms of your agreement. That way, if a dispute arises, you will have some evidence of what was agreed.
These are the basics. For any given startup, a dozen or more legal issues may surface within months of launching but failure to obtain sound legal advice on any of these could lead the startup down the wrong track.
If you need advice in relation to these or any other legal issues, please feel free to contact our startup partners:
By Dan Harris on January 6, 2012.
We lawyers are known as deal-killers. Most lawyers get offended by that moniker and vehemently deny it. Me, I am more than willing to own up to it. Clients go to lawyers all excited about a deal and it is the lawyer’s job to point out the risks and to explain which of those risks can be mitigated and which cannot. I am proud of the deals I killed because my killing the deal meant I was doing right by my client. In other words, I was just doing my job.
I have put the kibosh on many a China acquisition and that is what this post is about. The following is actually an amalgamation of many such potential acquisitions, but for ease of explanation and to camouflage the identities of those involved, I have amalgamated a bunch of them into one. Trust me when I say that the following is incredibly typical, including the retirement of the owner precipitating the need for the deal.
The potential deal was for a US manufacturer that had been receiving its product from the same China manufacturer for about fifteen years. The Chinese manufacturer had been providing about 90 percent of its product output to this one US manufacturer and the two companies had a “fantastic” relationship. The owner of the Chinese manufacturer had done very well over the years and he now wanted to retire and sell his China manufacturing business to the US manufacturer.
In theory, this made complete sense.
The US manufacturer told me of its plans to buy and we briefly discussed some terms and “the numbers.” They said that the Chinese company was clearing about “a million a year” but that was not why they were buying it. They were buying it because they wanted to be sure they would be able to keep getting the product.
I then told laid out the likely reality of what was to come. I told them that if they bought the Chinese manufacturing company their profits (if any) would likely be considerably lower. I proceeded to explain why this would probably be the case.
I said that there is a good chance the Chinese manufacturer is paying half of its employees completely under the table and reporting to the government only half of what it was paying the other half. I then talked of how there is also a good chance the Chinese manufacturer is underpaying its taxes and of how its rent also may be paid under the table. I then said that this sort of thing may be all well and good for Chinese companies, but that if the US manufacturer were to buy this Chinese manufacturer, it would need to do so as a WFOE and it would then immediately be on a “whole ‘nother level” with respect to China’s various tax authorities.
I then told the US manufacturer that if it were to buy the Chinese manufacturing business, it would need to bring every single employee onto the payroll and that would likely mean the payroll expenses would be close to doubled. I then gave my estimated numbers. All of the wages now being paid under the table would need to be paid above the table and that would mean that the US manufacturer would, in turn, need to pay all sorts of employer taxes, pensions, and insurance. I told the US manufacturer to figure that these items would be about 40% of all wages. So if you have an employee who is now getting $1000 a month under the table and you then report to the government that you are paying that employee $1000, you should figure on needing to pay about $400 on that to the government.
But it gets worse. Much worse.
You see, that employee who is receiving $1000 under the table is usually quite happy to be getting paid under the table. So when you tell that employee that you are now going to be reporting his or her wages/income to the government, that employee is going to demand a raise. You see, that employee has been able to avoid having to make his or her various employee contributions and to pay his or her income taxes and your now reporting his or her income will end all of that.
You should expect needing to raise employee salaries by maybe 40 percent. So now the employee who was getting $1000 is getting $1400 and you as the employer are going to need to pay an additional 40 percent on that, which equals around $560. So all of a sudden the employee that cost the Chinese manufacturer $1000 a month is going to cost you pretty close to $2000. In other words, double.
And let’s take rent. The Chinese manufacturer is probably paying the landlord under the table and the landlord is not reporting it. Heck, there is a very good chance the landlord is not even legally able to lease out the property, but for the sake of the numbers, let’s assume that the landlord is actually authorized to lease it. If you are going to buy the Chinese manufacturer’s company you are going to have to do so as a WFOE and to get a WFOE approved at all, you are going to need to have a legitimate lease. That means that before you buy this Chinese manufacturer, you are going to need to go to the landlord and tell it that you need to get your landlord-tenant relationship “on the grid” and that the landlord is going to need to register the lease with the appropriate authorities.
The landlord will likely call you an idiot (trust me on this) and initially balk. You will then need to explain that you absolutely must get on the grid and that you are prepared to cover the landlord’s increased costs to do so. Figure on this raising your rent by around 25%. Again though, this assumes that your being able to stay at this facility is even possible.
Okay, so now that I have explained how the above will eat into your numbers, let’s talk about income taxes. You are going to have to pay income taxes on the money you make, even though the Chinese manufacturer maybe never did. Figure 25% of your profits will go to income taxes. And if you are now thinking that you are not going to have any profits, let me tell you that is likely going to matter less than you think for Chinese income tax purposes. You see, if you have no profits, the Chinese tax authorities will figure that is because your Chinese WFOE is intentionally under-pricing the product it is selling to your United States operations and it will then impute a profit to your Chinese WFOE. It’s a transfer pricing thing.
You need an accountant who understands China to look over the Chinese manufacturer’s books and to run the numbers to see if this deal is going to make sense.
A few months later, I received the following (doctored) email from our US manufacturer client:
Here is where we stand:
Our accountant is in the process of re-modeling the business from a top-down perspective, in an effort to clarify what the numbers would be for our China WFOE, while complying with the rules. We have good history on the revenue and most of the operating costs.
As you guessed, we will need to apply roughly a 2x factor to the labor costs that the Chinese manufacturer is showing, so as to properly book all of the official upcharges.
Also, as you suggested might be the case, the landlord of the factory space is not properly registered, so we will be increasing the booked rental costs as well.
The reality is that we probably will not be purchasing the Chinese manufacturing company did not sit well with its owner. He was offended when I reiterated my stance that I wouldn’t operate the business in the same manner as he has. He lost face.
A few weeks after that, I received the following email from the client (again doctored):
it is now clear that we shouldn’t consider buying [the Chinese manufacturer]. He [the owner of the Chinese manufacturer] had previously indicated that there were “a couple” more issues related to the accounting procedures. I pressed him to explain if there were any others. Of course, you know the answer to that.
In summary, it is becoming clear that we cannot be profitable in China if we follow all the rules. It is not completely clear this is really the case, since we can’t tell if [the owner of the Chinese manufacturing company] really understands the rules. What is certain is that the numbers on which we had been basing our valuations are simply not valid. The “profits” that the Chinese manufacturer was claiming to have achieved are not valid under our business model.
Amazingly enough, the US manufacturer and the Chinese manufacturer came up with a great solution which ended up working like a charm. The manager of the Chinese manufacturer bought the Chinese business and continued running it just as before and the US manufacturer and the Chinese manufacturer have maintained their “fantastic” relationship. All is well, except my law firm made a lot less money than if the deal had gone through.
To read the original China Law Blog article, please click here.