The FMCG2019·China FMCG Conference, hosted by New Distribution, was grandly held from August 20 to 23 at Shanghai Fuyue Hotel! The event attracted 3,000 industry professionals, including distributors, manufacturers, and internet companies from across the country, filling the venue to capacity. The following content is the speech delivered by Li Xinhao, consulting partner of New Distribution, at the conference, organized and published for our readers. Good morning, friends of New Distribution! I am Li Xinhao, a consulting partner at New Distribution. The theme of my sharing today is business architecture. This term may sound a bit unfamiliar. Just now, I listened to Mr. Nie's talk, which focused on front-end methods for business operations. My content, however, involves the implementation and execution of these methods. Over the past decade or more, I have been providing financial and tax management consulting services to enterprises. I have visited many companies, from listed companies to small distributors and stores. After visiting many enterprises, I noticed a phenomenon: Many businesses in China are built on a certain resource or opportunity. When that resource or opportunity passes and becomes scarce, the sustainability of these businesses may be greatly affected. In recent years, you should have felt this, such as traffic dividends and capital dividends. Another opportunity, so familiar that we often overlook it, is regulatory leniency. In the past few decades, thanks to domestic regulatory leniency, many enterprises achieved rapid growth. Many instances of rough-and-tumble growth in operations went unnoticed by regulators (mainly the tax authorities for distributors), and that's how they passed. You bosses should have felt this. In fact, there are objective reasons for regulatory leniency. The biggest reason is the limitation of collection and management capabilities. The largest tax bureau in Beijing is in Haidian, where each tax administrator manages over 3,000 enterprises on average. If they visited two enterprises a day, it would take four to five years to cover all. So objectively, regulators do not have the capability to understand the true operations of every enterprise. However, the situation has changed dramatically in the past two years. Many things have happened in the regulatory field, the most important measure being the launch of the Golden Tax Phase III system. The most important achievements of Golden Tax Phase III are two things: First, it achieved centralized national data. Previously, corporate financial and tax data was local; if you encountered a problem, you could find someone to smooth it over. Now, it's directly in the system of the State Administration of Taxation. Second, it uses the system for risk warnings. This year, across the country, from Beijing to fourth- and fifth-tier counties, many places have eliminated the position of tax administrator, replaced by risk control teams. These people used to do audits. Now, when the system detects problems in your financial data, it automatically alerts, and the responsible person must write a written response. I don't know if you've encountered this. I have encountered it many times this year, helping enterprises deal with it. Based on the functions of Golden Tax Phase III, policies have been introduced more and more frequently. At the end of last year, when the new individual income tax law came out, a boss told me, "If the banking and tax systems could be connected, it would be too harsh on bosses." Not long after, two months ago, the central bank, the Ministry of Industry and Information Technology, the State Taxation Administration, and the State Administration for Market Regulation (formerly the State Administration for Industry and Commerce) jointly launched an information networking verification system. According to public reports, this system can check a company's registered information in these agencies, including e-commerce platforms, bank accounts, and ID information of legal representatives and shareholders. That's the first step. What's next? You can use your imagination. At dinner yesterday, I met a boss from Sichuan who told me that the regulatory situation in recent years is "loose on the surface but tight underneath." Compliance is no longer a multiple-choice question but an essay question: How should you achieve compliance? Some bosses say compliance is simple; they can hire an external team or a good accountant. I must say, having this idea is good, but note that compliance management or transformation is not primarily driven by external forces or your accountant. The real decision-maker is the enterprise's decision-maker and helmsman. Why do I say this? In the past, many bosses introduced their business by saying what products or services they provide and what value they offer to which customers. But there is a side that is often overlooked: how regulators view you, whether you face tax authorities or capital markets. How do regulators view you? They look at the basic logic of your business: Are you a trader, a manufacturer, or a new business model? What are your tax subjects? What are your taxable activities? Is the invoice you issue real or fake? How can you prove it? Only the boss who runs the business can clearly answer these questions. Compliance management is the first thing a boss must put in place for compliant transformation. When facing regulators, the perspective is what we call business architecture today. What is business architecture? It is the description of the legal relationships, business relationships, and interest relationships among various operating entities under an independent business model. To understand business architecture, you mainly need to clarify these five things: First, the financial model. The financial model reflects business revenue, costs, and expenses. But what I want to say is that this financial model is your external one, but one day you will need to explain your business to regulators. For example, if you were in trading and you spent 5 million yuan on promotional expenses through various means, why did you spend 5 million on promotion? You need to be able to justify it. This financial model must pay attention to the data shown to regulators, because you can't change this number. When your explanation doesn't match it, the tax authorities will see it at a glance. Second, around the financial model, you need to build an organizational structure for the business you describe to regulators. How many companies are there, and what are the relationships between them? Third, the investment structure. What do you invest with? Individual? Company? Fund? Or do you find your brother-in-law to set up an individual business to issue invoices for you? Fourth, the transaction structure. How do you obtain invoices from your upstream or issue invoices to your downstream? For what reason, and what was done? Fifth, the income route. When you put all the money you earn into your personal pocket, there are different routes. Some are direct transfers from company accounts, paying 20% dividend tax, or paying 45% as bonuses. If you use other methods, there are many precautions. To summarize simply, business architecture is about preparing a logical explanation for your business to the outside world, and based on this, build your organization, investment, and transactions. Finally, the money you earn must take different routes back to your pocket. Everyone here is a distributor, all in trading. **For future compliant transformation, there are many directions. Growing bigger is one path. Additionally, in recent years, I have seen many trading companies transform into supply chain service platforms. Generally, they rely on traditional trade and add value-added services, such as IT services, logistics services, financial services, and resource integration, to become an ecosystem of supply chain industry services. At the end of last year, a boss asked me to do an architecture for him. He previously had a trading company and obtained a new product formula to develop a new business. First, I put his old business into a newly established trading company; the original company was transformed into a holding company. Above the holding company, there was an actual controller, and a shareholding platform was set up, with the actual controller as GP; the new product was transferred to a new food R&D company, holding the formula and blending; the new product company was mainly responsible for sales, while production was outsourced; for e-commerce, a technology company was found to provide services. It would take an hour to explain the entire architecture, so I'll briefly mention it. **This architecture focused on four things: **First, it changed from a single company to an industry chain service platform, including R&D, IT, sales, and production; **Second, the overall tax burden was significantly reduced; **Third, employee incentives were implemented; Fourth, it left room for future listing. From this example, business architecture has three very significant values for enterprises in compliant transformation: First, from a financial and tax perspective, it achieves operational compliance. The boss himself and the money he receives are safe. Second, it reduces the overall tax burden, but the reduction varies depending on the business type. If you are in manufacturing, your scale, site, buildings, and factories are clear, so it's hard to say; if it's a new business model like IT, ten people might generate 100 million in output, and there is a lot of room for adjustment. Third, it provides flexibility. When the boss came to me, he said he had made money over the years but hadn't grown the business much. He hoped to have the opportunity to build a listed company or be acquired. So, first, I designed an architecture that ensures he can maximize returns when he doesn't want to connect with capital, and when he needs to connect with capital, he can effectively balance profits among related entities and holding companies. Business architecture can provide entrepreneurs with many valuable things, but when doing it, you need to solve many practical problems. A few years ago, when the New Third Board was popular, a boss wanted to list on it. The New Third Board requires revenue to be reflected on the books, which means a high tax burden. The boss calculated the tax to be tens of millions and gritted his teeth and paid. Not long after paying, the tax authorities came, because the significant fluctuation in revenue caused a significant fluctuation in taxes. The tax authorities knew exactly why: you must have evaded taxes in the past. So the result was a fine of over 10 million, and the New Third Board listing was abandoned. So, compliant transformation must solve practical problems. Here are several strategies: First, have a method. The method is to use business architecture to build a framework that can effectively solve problems, but note that each enterprise's point is different, especially the transaction structure. For example, what are your upstream and downstream contracts? This is most closely related to taxes. Second, have a bottom line. What is the bottom line? It's the things that can be seen at a glance through data. For example, buying invoices or inflating headcount. After social security is collected by the tax authorities, if you compare, it will be exposed. This is the bottom line, a red line that must never be crossed. Third, have a cycle. When you want to transition from the current state to a more compliant state, there is a process. It's unrealistic to want to be compliant today and be compliant tomorrow. Compliance requires methods and must solve practical problems. Next, I will share some very practical issues that everyone cares about in the current domestic situation when it comes to compliant transformation. First, private account receipts. Among non-listed private enterprises, very few do not use private accounts for receipts. There are many objective reasons for private account receipts, such as earning 5 million, but before distributing, you first pay 25% corporate income tax, then 20% individual income tax, and 40% is gone. If you have friends who insist on doing this, you can tell them to pay attention to a few points. First, match your apparent business scale. At a glance, it should not be obviously inconsistent with the data you report. If you have a three-story house, but you tell me you paid 20,000 in taxes, who would believe it? This is called matching apparent business scale. Those with factories must pay special attention. The current Golden Tax Phase III has the ability to assess your production capacity based on your utility bills. Second, be cautious with account handling. If you must use a private account to receive money, never use the legal representative's account. If you use a private account, avoid abnormal fluctuations. Receiving 20 million in one day, or large amounts of money flowing in and out repeatedly when you need money, can easily be seen as money laundering. Third, maintain strict confidentiality. If you really do this, ensure that many things are not spread. I encountered a boss in Wuxi who was maliciously reported by a former employee. The tax authorities now, for real-name reports, must give a formal response. As a result, the boss was investigated and had to pay back taxes of over 10 million. Of course, private account receipts are still not recommended, as it strictly constitutes tax evasion. Second, the problem of high tax burden. For high taxes, try to get invoices as much as possible, but don't buy them. Second, value-added tax is harder to handle; there are methods, but very few. Third, transaction transfer. Some new business models, such as social e-commerce and community group buying, involve payments to individuals without invoices. But if you pay 20% as labor remuneration on their behalf, everyone is looking for solutions. If not handled well, this solution can easily become false invoicing, but many enterprises use it. Many individual businesses in the market do this: you design a transaction, for example, you buy a lot of vegetables, but the market sellers don't have invoices. You can have your brother-in-law set up an individual business to buy from the market, and as an individual business, he can issue invoices to you. If the scale is large, you need to design the transaction. This is transaction transfer. If not handled well, it becomes false invoicing. If your brother-in-law really does this business, it's fine. But if your brother-in-law only gives you a contract, with no logistics information, no warehousing information, only verbal agreement, that won't work. The reasonableness of the transaction must be provable. When money goes into your brother-in-law's pocket, it cannot be transferred back to you via bank transfer. This is called capital return, and the tax authorities' key basis for determining false invoicing is capital return. Third, equity design. Equity has been a hot topic in recent years. On the afternoon of the 20th, Mr. Xu talked about the points system, which requires many of these things. Equity involves many aspects, so I'll briefly mention a few key points: First, the arrangement of interests for shareholders or partners doesn't have to be all through equity returns. It can be short-term bonuses and dividends, mid-term agreed value exits, or long-term equity premiums, usually through acquisition or listing. Second, if you plan to do equity incentives in the future or for other reasons your equity is diluted, it involves the issue of the operator's control over the enterprise. There are many methods. There are many stories about Zhen Gongfu and Haidilao. In most current domestic private enterprises, an effective way is through partnership enterprises. It's simple and convenient to operate, and can be solved through agreements. As the GP of the partnership, you only hold 1% of the partnership, but you can have 100% decision-making power, so it is often used as an employee shareholding platform. Third, individual income tax on exit. Generally, when you receive all returns through dividends or equity transfers, you need to do corresponding tax planning. One day, when your company is acquired by another company, and the company has a several-fold premium, a company you originally invested 1 million in might become 20 million in the future. At that time, you will have a high premium, and individual income tax is 20%. At this point, you can make some appropriate arrangements, and the tax-saving effect can be around 30%. Fourth, employee incentives. This is a big topic, including bonuses and equity. If you plan to use equity to incentivize your employees, directly linking their performance to the company's overall operating results, in addition to the financial standardization and operational transparency that Mr. Nie just mentioned, you also need a method to link their contributions to the dividends they actually enjoy from the equity. This is called dynamic equity. Dynamic equity has many practical uses. For our industry, positions linked to data are easier to implement. If it's not easy to link to data, you can pay attention to the points system that Mr. Xu talked about the day before yesterday. I've talked a lot just now, covering tax issues, income issues, and equity issues. In our traditional view, these are individual problem points, but in reality, behind these points are systematic problems. The thinking framework of business architecture I shared today hopes to provide you bosses with a new perspective to re-examine and re-view your business. A few months ago, there was a well-known company, Baofeng Technology, whose boss encountered some problems. There were many comments online. Among these comments, the one that impressed me most was from a law professor: "Many Chinese enterprises today often face not market risks, but regulatory risks." I hope that the business architecture I shared today can give you bosses a helping hand in your next steps of sustainable growth and expansion.