How to conduct company due diligence in China: a 2024 Practical Guide

Summary

• Challenges: Conducting due diligence in China presents unique challenges, including language barriers, internet restrictions, and decentralized information sources.
• The Methodology: This practical framework, developed by Knowaco, guides the due diligence process by focusing on four key areas: Identity, Legal risk, Operational risk, and Financial risk.
• Practical Guidance: The guide offers insights and instructions on conducting company searches / due diligence in China, including:
  • Identifying the formal company name or social credit code
  • Utilizing official or credible sources for information
  • Analyzing identity data, operational risks and capabilities, legal and compliance risks, and financial risks

1. Challenges of conducting company due diligence in China

In recent years, with transformations such as the public disclosure of enterprise information and the implementation of the unified social credit code, it has become easier to obtain information on companies in China. However, for foreigners looking to do business with Chinese companies, there are still some obstacles to obtaining and analyzing relevant information about Chinese companies for decision-making, such as:

1. Language barrier: Some Chinese companies do not disclose their official Chinese names or other identity-related information in their marketing promotions, making it difficult to accurately identify the company's identity and conduct background searches.
2. Internet restrictions: Accessing the National Enterprise Credit Information Publicity System (NECIPS) or services provided by market data aggregators, such as QCC, may involve network restrictions or technical barriers.
3. Decentralized information: Besides basic company registration information, other information, such as court records, tax compliance records, administrative penalty records, land and real estate mortgage records, etc., is scattered across various sources.

This guide is based on our experience in conducting company due diligence on Chinese companies, aiming to provide practical guidance for addressing the challenges mentioned above and for conducting the analysis more effectively.

2. The iLOF model in company due diligence

The iLOF model is a practical method we developed for conducting due diligence on Chinese companies. It contains four primary elements that we should consider.

The iLOF model allows for the comprehensive utilization of various data sources and enhances the thoroughness of the analysis. Here's a brief explanation of the iLOF model:

• (i) Identity: A company's legitimacy and credibility, including searching for a company's registration details, shareholders, management, ultimate beneficiary owners, subsidiaries, and the company's registration history and status.
• (L) Legal risk: Litigation cases, court hearing records, court announcements, and relevant legal records of major shareholders and directors. It also includes compliance records, which typically encompass relevant blacklists and sanction lists.
• (O) Operational risk: size of the company, office and production facilities, number and qualifications of employees, production capacity, negative information related to products and services, and any abnormal status, etc.
• (F) Financial risk: Tax qualifications and status, financial condition, asset mortgage situation, credit rating, whether involved in bankruptcy, reorganization, and liquidation, etc.

3. Practical guidance in conducting company searches in China

Identify the formal company name in Chinese or its social credit code

Do not be fooled by how sophisticated a company's promotional website or language may seem. The most fundamental and crucial step in conducting a company due diligence is to identify the correct entity behind the business.

As you may know, companies registered in China do not have official English names, so searching for company information solely through the English name is insufficient. Further searches can be conducted only after obtaining the company's formal Chinese name or unique identity number (e.g., the Unified Social Credit Code).

If you do not know the company's official name or unique identity number (i.e., the Unified Social Credit Code), consider the following actions:

1. Ask the company for their business license or relevant information if they are aware of your inquiry.
2. Search public information like website content, domain names, Alibaba homepage, and images to find clues about the company's official name.
3. Use known details like the registered address, factory location, and brand name for further inquiries.

Please read the following article about this topic.

How to conduct background check on a Chinese company if you only have its English name?

A Chinese company does not necessarily have an official English name, as only a Chinese name is required by law for business registration, making it difficult to perform a background check if you are provided only with the company name in English. Some web articles may suggest you search the

Knowaco BlogKnowaco Editor

Use official or credible services to obtain information

You can obtain relevant data through official data sources, such as the National Enterprise Credit Information Publicity System or services provided by data aggregators.

If you cannot locate results using the company’s official Chinese name or the Unified Social Credit Code, remain cautious of potentially fraudulent registration.

Analyze the identity data obtained

The most direct way to assess a company's status is to check if its registration status is normal. Abnormal statuses include the cancellation or revocation of the business license, among others. Please read the following article for detailed explanation about registration status.

Understanding the 8 Business Registration Statuses in China

In China, the Administration for Market Regulation (AMR) maintains a comprehensive business registration system. This system tracks each company’s status, providing information about its operational health and potential risks. Understanding the eight critical business registration statuses can be crucial for making informed business decisions and assessing business opportunities. 1. Existing:

Knowaco BlogKnowaco Editor

Another action is to compare the data retrieved from the searches with the information displayed or provided by the company to check for any discrepancies, which may indicate risks. Examples of such risks include:

1. A company claims to have been in the business for 20 years, but its registration information shows it was established this year.
2. A company's website states that it has 100 employees, but the number of employees retrieved from the search is zero.
3. A company displays several photos of high-end offices on its website, but the registered address shows it is a private residence.

Analyze operational risks and capabilities

To assess whether a company has the qualifications and capabilities to engage in certain business activities, consider the following information:

1. Business Scope: Verify if the business scope listed in the company's registration information includes the products or services of interest. Discrepancies between the declared business scope and actual operations may indicate risks.
2. Qualifications: Check for any relevant qualifications the company has obtained, such as product, quality, safety, and environmental certifications (including ISO certifications, industry management standards, etc.)
3. Shareholders: Identify the company's shareholders and their business and background situations. This information can provide insights into the company's stability and credibility.
4. Operational address: The company's office address can indicate its professionalism and operational environment.
5. Employee count: The number of employees can reflect the scale of the company's operations.
6. Production facilities: The presence of factories or production facilities can indicate the company's capacity to produce goods or provide services.
7. Advsere records: Look for any negative information related to the company's products and services, including negative news, penalties, fines, customer complaints, and safety issues.

Analyze legal and compliance risks

To assess a company's legal and compliance status, including litigation disputes, it is essential to consider the following aspects:

1. Litigation disputes: Pay special attention to cases where the company is the defendant, particularly those that:
   • Have a significant negative impact on its reputation, such as cases that have already affected the stability of its business.
   • Involve potentially large dispute amounts that could lead to a deterioration of financial conditions.
   • Indicate significant flaws in the company's management or production capabilities.
   • Violate ESG requirements, such as labor disputes, product quality, and environmental damage.
   • Involve high-risk cases like bribery and corruption.
2. Other court records:
   • Enforcement of cases: Any records about the company or its shareholders and executives do not cooperate with the enforcement of court orders, or there are dishonest behaviors.
   • Notifications of restricted high consumption: Any records about the company or its shareholders and executives are restricted from "high consumption" due to other disputes, such as being unable to take airplanes or certain train carriages, indicating potential integrity issues.
3. Blacklists: Common blacklists in China include the list of dishonest persons and the government procurement blacklist.

By examining these areas, you can gain a thorough understanding of a company's legal and compliance posture and identify any potential risks or issues that may affect your decision to engage with the company.

Assessing Financial-related risks

The information obtained from a corporate background check can also be further analyzed from a financial perspective.

1. Tax status. Check for any tax non-compliance, such as records of tax arrears or tax penalties. Generally, tax ratings (classified into A, B, C, D and M categories) can also be used as a reference.
2. Encumbrance of tangible and intangible assets. Look for any records of mortgages on the company's held shares, real estate and other current/non-current assets. Unreasonable encumbrances may indicate that the company is facing liquidity issues.
3. Involvement in Bankruptcy, reorganization, and liquidation. If a company is involved in such situations, it suggests that its operational and financial conditions are quite fragile.
4. Data analysis through financial information. (The financial statements shoulb be provided by the company or obtained through third parties)

In addition to routine background checks, sometimes to verify and analyze information, we can employ more tools and methods, such as:

1. Document authentication: Analyzing whether the materials displayed or provided by the company have been tampered with or photoshopped.
2. Public Information verification: Using methods like IP address lookups and domain name reverse searches to verify publicly available information.
3. Relationship / connection analysis: Examining the relationships between companies/key individuals to identify any affiliations, partnerships, or shared ownership that might not be immediately apparent.

1. Instant Company Search: Get automated company search reports within minutes.
2. Knowaco Blog (Knowledge center) - Key Points: Essential knowledge for conducting company background checks / due diligence and understanding the findings.
3. Know-about-a-company Checklist 2024: A checklist for company due diligence in China.