Structure and regulation of Sino-foreign joint ventures

In recent years, the volatile world economy and geopolitical tensions have further complicated the development of Sino-foreign joint ventures in China. Such developments have given rise to a series of innovative models of Sino-foreign joint ventures, including the Model 2.0, in which the foreign industrial investor provides technology and/or injects specific businesses, the Chinese and foreign financial investors provide funds, and an employee incentive platform is set up to provide equity incentives. China has also recently promulgated and implemented a number of new laws and regulations on foreign investment, company law, IPOs and compliance.

Legal and regulatory system

To encourage foreign investment in China, the Foreign Investment Law, effective since 1 January 2020, and its implementation rules have laid down the principle of equal treatment for domestic and foreign investment in sectors beyond the negative list. Foreign-invested enterprises are required to adjust their organisational form and structure in accordance with the Company Law and other applicable laws before 31 December 2024 (such as shifting the highest authority of the joint venture from the board of directors to the shareholders’ meeting).

In addition, the revised Company Law, effective on 1 July 2024, has made major adjustments to the registered capital system and the responsibilities of directors, supervisors and executives, and corporate governance of companies (including foreign-funded enterprises). For example:

• In terms of capital rules, the new Company Law further strengthens the principles of capital replenishment and maintenance, setting a five-year limit on capital contribution of shareholders of limited companies after subscription. The existing companies are in principle required to adjust their capital contribution timeline within the three-year transitional period that ends on 30 June 2027;
• Relevant obligations and liabilities of directors are strengthened and refined, including the obligation to prevent illegal withdrawal of capital and related compensation liabilities, urging shareholders to pay capital contributions, compensation liabilities for illegal capital reduction or profit distribution, and liquidation obligations and related compensation liabilities;
• Adjustments are made to the corporate governance structure, such as allowing a limited company to set up an audit committee composed of directors in place of the board of supervisors, and exempting small companies from appointing supervisors or setting up a board of supervisors with the unanimous approval of shareholders.

Sino-foreign joint ventures, especially existing ones, facing both the transitional period under the Foreign Investment Law nearing its end and the transitional period under the revised Company Law, should review and set or adjust their corporate governance structure and capital contribution timeline in line with both laws to ensure a smooth transition.

Exit options

IPOs provide a significant return on investment for Chinese and foreign investors, enhancing the visibility of joint ventures, expanding fundraising channels and improving corporate governance. China’s capital markets, young and fast-growing, have multiple exchanges and boards serving a variety of companies and investors, including the main boards of the SSE and SZSE serving large and well-established companies, the SSE Star Market and SZSE ChiNext targeting innovative tech firms, and the BSE and the National Equities Exchange and Quotations targeting small and medium-sized businesses.

China adopted a registration-based IPO system across the board from February 2023. With information disclosure at the core, the system emphasises the basic legal compliance and financial discipline of enterprises under the principle of materiality, loosening the IPO requirements regarding financial indicators, ownership clarity and special voting rights.

For example, ChiNext supports the IPOs of eligible unprofitable enterprises, and cancels the IPO requirement of “positive net profit in the past year” for red chips and enterprises with special equity structures.

On the other hand, the Opinions of the State Council on Strengthening Supervision, Preventing Risks and Promoting High-Quality Development of the Capital Market, issued in 2024, tightened domestic IPO regulation across the board to protect investors (especially small and medium-sized investors) more effectively and expedite building safe, standardised, transparent, open, dynamic and resilient capital markets, with a focus on strong supervision, risk prevention and high-quality development. Against this backdrop, M&A may remain a major exit option for many foreign investors at present.

Employee incentives

Employee incentives are an important part of the structure design of Sino-foreign joint ventures. In particular, businesses engaged in high-tech research and development, and intelligent manufacturing, are more eager to provide employee incentives to attract, retain and motivate top talent to create and maintain a competitive edge.

A sound and effective employee incentive mechanism will link employee income with the growth of enterprise value, boost employee morale and control cash spending effectively.

For joint ventures, employee incentives may take the form of equity incentives (e.g. options, restricted shares and employee stock ownership plans) or cash incentives. Equity incentives, if adopted, are generally divided into direct ownership (directly holding shares in the company, subject to statutory requirements on the number of shareholders) and indirect ownership (holding shares in a limited partnership established as an employee incentive platform).

In addition, key considerations in incentive planning include the scope of eligible employees (Chinese and foreign employees and/or external consultants), approval and management of the incentive plan, the source of funds, exit arrangements, tax planning, share payments and alignment with an IPO and M&A. Under the new Company Law, such issues as employees’ payment of consideration and fundraising should also be considered in line with the time limit for registered capital contribution.

Compliance

Due attention should also be paid to compliance issues under China’s laws regarding the establishment and operation of joint ventures, including the following.

First, the declaration of concentration of undertakings. When Chinese and foreign investors establish joint ventures or acquire shares of joint ventures, it is necessary to assess whether they constitute a concentration of undertakings under the Anti-Monopoly Law. Where the deal constitutes a concentration that reaches the turnover-based declaration threshold, the investors shall make a declaration prior to concentration. Laws and regulations such as the revised Anti-Monopoly Law and the Rules of the State Council on Declaration Thresholds for Concentration of Undertakings have raised the turnover-based declaration threshold, and also raised the liabilities and consequences of illegal concentration.

Second, national security review. If foreign investors invest in the military industry or other fields related to national defence and security, or invest as de facto controllers in important agricultural products, important energy and resources, key technologies and other important fields related to national security, they shall take the initiative to declare it prior to investment.

Third, with the Cybersecurity Law, the Data Security Law, the Personal Information Protection Law and other applicable laws, regulations, rules and standards promulgated, joint ventures shall exercise greater care in the collection, storage, use, processing and transmission (especially cross-border transmission) of data and personal information in the course of business.

In addition, due attention shall be paid to China’s legal and regulatory requirements on foreign exchange, taxation, customs and technology import and export with respect to the establishment and operation of the joint ventures as the requirements are updated from time to time.