The Entrepreneur’s Dilemma: How much Money do I Invest in my China Business? Will my Debt Capacity be Enough?

This conversation came up during my interview with German Torrado and David Caro, who are about to launch Real Madrid branded products in retail in China (you can read that post titled “Selling a Hot License to the Chinese Retail: a Door-Opening Strategy” here) . Their project sounds exciting and there was only one thing they were concerned about: shall it turn out to be too successful?

But before I get into the thoughts they shared, and just to provide a bit of a background to those less familiar with a WFOE set up process, I will give a very simple explanation of three concepts that WFOEs have to decide upon when they start their operations in China: Registered Capital (the equity they will pledge), Total Investment (amount necessary to realize the company’s operations) and Debt Quota (debt limit allowed-which is the difference between the previous two).
There are rules that establish what the ratio R.C. and T.I. must be given every level of investment.  So for a simple example, if your registered capital is 70.000RMB, your maximum total investment will be 100.000 RMB and your debt limit will be 30.000RMB (as the ratio of R.C. to T.I. for investments bellow 3 million US$ is “at least 7:10”).[1]

And now, going back to the points of an entrepreneur’s dilemma, here you will find some of their thoughts and considerations:

#1. How much money do I invest? I do not want to get more money locked in China than required, as I cannot easily take it back if needed….
“ We have always tried to approach our business in China in a relatively “conservative” way. We have seen too many businesses going wrong and we did not want to get trapped in an oversized business with difficulties repatriating our own money… “.

#2. Financing through debt has a lot more limitations than back home.
“Back home we can easily get loans to finance our business growth. Here we have the limits imposed by our registered capital… and additionally, corporate banking is in a very primitive stage here. The range of financial products that we can enjoy back home is much broader.
I may be exaggerating, but in the case of a foreign business in China, your company is worth whatever your available “cash” is…. They limit too much your ability to use debt to finance your growth”

#3. Is it not easy to get a loan in China.
“It is not easy for a foreign company to get a loan in China… We have been able to get loans here, but we had to use a Spanish bank that guarantees the payment to the Chinese bank”

#4. So, if the business turns out to be very successful, we risk not being able to quickly react to the increased market demand.
“Right now, our biggest concern is that, if this project goes extremely well, we may have a bit of a difficulty re-dimensioning our business due to the limitations imposed by the foreign debt quota and the time required to increase capital. We will need further financing to increase product procurement to be able to serve clients’ orders. And we will probably need to invest on more fees too.

Having said this, we still feel more comfortable with the “step by step” approach we are taking, rather than trying to start too big and get our money locked in here”

So what can we do? In my next post, we will read a few tips from German Torrado on how to navigate through this funding shortfall while you manage to increase your capital.

Did you face the same dilemma when you started your business in China?

[1] There are plenty of sources providing information on these ratios, you can check this link for a reference.

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