Navigating Market Entry in China: Incorporation vs PEO Strategy

Expanding into China, businesses often encounter the daunting task of managing administrative responsibilities, which can detract from focusing on their core operations. The dilemma lies in selecting the most efficient pathway: establishing a local entity, typically as a subsidiary, or leveraging the services of a PEO.

Contributing Advisor

David Niu

Partner

The global shift towards remote work has highlighted the necessity of adapting business models to include cost-effective and flexible work arrangements. In response to this new normal, companies worldwide are reconsidering their physical office spaces and exploring how to optimize international team building while minimizing costs. This is where the strategic choice between incorporating a local legal entity or partnering with a PEO becomes crucial.

Both options offer distinct advantages and considerations in terms of operational ease, cost-efficiency, and time to market. This article aims to equip businesses with the insights needed to evaluate the best route for their entry into the Chinese market, considering the unique opportunities and challenges presented by this vibrant economic landscape.

Incorporation in China

Foreign investment can be made via one of several types of investment vehicles. Choosing the appropriate investment structure for your business depends on several factors, including its planned activities, industry, and investment size. 

It is crucial to consider various aspects of the target entity types before deciding which kind of business to launch. These include differences in structure, legal liability, statutory compliance requirements, time needed to set up the business, the kinds of activities the business can engage in, and more. These factors aid in determining the proper business costs, requirements, risks, and limitations needed to support the company's future development, growth, and intended capabilities.

In the table below, we’ve described these factors for each primary entity type that can be established in China. 

Professional Employer Organizations (PEO) in China

Private Employment Organizations (PEOs) assist businesses, especially small and medium-sized ones, by managing employee-related tasks such as payroll and benefits. This co-employment model allows companies to focus on their core activities while the PEO handles complex HR responsibilities.

How does a PEO operate?

At the heart of a PEO's operation lies the co-employment model, a unique business relationship where both the PEO and your company share certain employer responsibilities. The essence of this model is a shared partnership: your firm continues to oversee the daily management of employees and core business activities while the PEO handles various administrative tasks.

Service agreements may differ for every company, but in a broader spectrum PEO works by:

• Sharing employer responsibilities: A PEO collaborates with your business in a co-employment relationship, sharing specific employer responsibilities. While the PEO manages payroll processing, tax withholdings, workers' compensation, and employee benefits, your company focuses on core business functions like product development and customer service.
• Customized service negotiation: The process begins with a negotiation between your company and the PEO to determine the scope of services. Legal requirements shape these discussions and may cover recruitment, payroll, and tax compliance.
• Contract signing and online management: Following the discussions, a contract detailing the responsibilities of each party is signed. Many PEOs provide an online portal for businesses to track payroll and employee information.
• Employee recruitment and onboarding: The PEO can either transition your existing employees or recruit new ones on your behalf, especially in international expansions. This includes providing compliant employment contracts and setting up payroll systems.
• Ongoing administrative and HR support: Beyond payroll, the PEO manages contractual, tax, and regulatory compliance issues. This comprehensive support extends to renewals, terminations, and regulatory submissions.
• Client company's role in management: While the PEO handles HR administrative services, your company retains control over employee management and non-HR business operations, such as marketing and customer service.
• Compliance and risk management: The PEO processes wages and benefits and ensures compliance with complex employment laws. This includes managing payroll taxes and workers' compensation and offering risk management strategies.
• Collaborative HR strategy: A PEO may work alongside your HR team, helping to address critical areas like employee relations and risk management. They can also assist in developing resources such as employee handbooks.
• Access to a wider range of benefits: Partnering with a PEO gives your company broader employee benefits, enhancing your ability to support and engage your workforce.

PEOs usually charge for their services based on your payroll or a fixed monthly fee per employee, offering a predictable cost model. This approach enables businesses, particularly SMEs, to enjoy the benefits of a comprehensive HR department without the overhead.

How much does a PEO cost?

PEOs generally charge based on a percentage of payroll or a per-employee, per-month (PEPM) basis often with an additional administrative fee.

Comparative analysis: Incorporation vs PEO

How using a PEO service could benefit your business

Partnering with a Professional Employer Organization (PEO) can be a strategic choice for companies looking to expand or operate in new markets without the complexities and costs associated with establishing a legal entity. PEOs offer a co-employment model where they handle various employee-related functions, making it an attractive option for certain business needs. Here are key reasons why a PEO might better suit a company’s needs compared to legal entity incorporation:

Cost efficiency

Partnering with a PEO often requires a lower initial investment compared to the costs of incorporating and maintaining a legal entity, including legal fees, registration, and ongoing compliance costs.

Speed to market

A PEO allows companies to quickly enter new markets without the time-consuming process of setting up a legal entity, dealing with regulatory approvals, and establishing local HR capabilities.

HR and administrative support

PEOs manage payroll, tax compliance, employee benefits, and other HR responsibilities, freeing up company resources to focus on core business activities and growth strategies.

Regulatory and compliance expertise

PEOs have specialized knowledge of local employment laws, tax regulations, and compliance requirements, reducing the risk of legal issues and non-compliance penalties for the client company.

Access to better employee benefits

Companies can offer their employees access to high-quality health insurance and other benefits at more competitive rates through a PEO, which can negotiate better terms due to its larger pooled resources.

Risk management and liability sharing

Partnering with a PEO can mitigate employer liabilities, as PEOs often share or manage certain risks related to employment, providing legal defense benefits and handling compliance inspections.

Scalability and flexibility

A PEO arrangement offers flexibility to scale up or down the workforce quickly without the administrative burdens and long-term commitments associated with operating a legal entity.

Local expertise without local presence

Companies can leverage the PEO’s local expertise and networks without needing a physical office or local staff, which is particularly beneficial for businesses in the early stages of exploring a new market.

Focus on core business operations

By outsourcing HR and administrative tasks to a PEO, companies can concentrate their efforts on strategic business operations, product development, and market expansion.

Ease of transition for future incorporation

Starting with a PEO can be a strategic step for businesses planning eventual incorporation in the new market, allowing them to test the waters and establish a business presence with less initial risk and investment.

Is incorporation the right path for your business?

Choosing incorporation over partnering with a Professional Employer Organization (PEO) can better align with a company's needs in several scenarios. Here are the key reasons why incorporation might suit some companies better than a PEO arrangement:

Full operational control

Incorporating allows companies to maintain full control over their operations, from strategic decisions to daily activities. This level of autonomy is essential for businesses that require direct oversight of their workforce, proprietary processes, or quality control standards.

Brand presence and market strategy

Establishing a legal entity solidifies a company's commitment and presence in a new market. It can enhance brand credibility and facilitate deeper market penetration strategies that a PEO, acting more as a behind-the-scenes partner, might be unable to support.

Customization of workforce and culture

Incorporation enables companies to build and manage their workforce directly, allowing for a tailored approach to hiring, training, and culture development. This can be crucial for companies with specific talent requirements or those aiming to cultivate a unique organizational culture.

Long-term investment and growth

Incorporation provides the stability and legal framework necessary to expand operations, enter into contracts, and secure financing or investments under the company's name for businesses planning substantial long-term investment and growth in a new market.

Intellectual property protection

Incorporation enhances the protection of intellectual property (IP) and sensitive data by establishing clear legal jurisdiction and compliance with local IP laws. Companies in technology, research and development, and creative industries might find this particularly important.

Financial and tax planning

Operating through a legal entity offers more opportunities for sophisticated financial and tax planning, including optimizing tax liabilities, accessing local financial incentives, and conducting transactions in the local currency.

Local compliance and governance

While PEOs can navigate local laws and regulations for their clients, incorporating allows companies to build in-house expertise in local legal and regulatory frameworks, which benefits businesses in highly regulated sectors.

Market perception and partner relationships

A local legal entity can foster trust among local customers, partners, and regulatory bodies, potentially opening up more significant business opportunities and partnerships that require or prefer dealing with locally incorporated entities.

Scalability and diversification

Although PEOs offer quick scalability for workforce size, incorporation provides the structural foundation for more comprehensive expansion, including opening new offices, diversifying product lines, and adjusting business strategies without external constraints.

Key differences

The table below outlines the key differences between legal entity incorporation and partnering with a Professional Employer Organization (PEO) in China, focusing on factors such as cost, time to market, operational control, regulatory compliance, and scalability:

Case study example

The following use-case comparison showcasing consideration points for Startups and SMEs versus Large Multinationals when choosing between Incorporation and partnering with a Professional Employer Organization (PEO):

Making the decision: Important factors and necessary steps

Choosing between partnering with a Professional Employer Organization (PEO) and opting for incorporation is a crucial decision that centers around balancing several key considerations. These include the desire for operational autonomy, the commitment to long-term market presence, and the need for flexibility, cost efficiency, and a streamlined process for entering new markets.

Making an informed decision between incorporation and a PEO strategy in China involves a strategic approach that includes a comprehensive assessment of business needs, consultations with local experts, and a detailed evaluation of the market and regulatory landscape. Leveraging local partnerships and expert advice can significantly enhance the decision-making process. It ensures that foreign businesses opt for the path that best aligns with their objectives, capabilities, and plans for successful market entry and growth in China.