Private Equity Investing In China

Transcription

1 Private Equity Investing In China May 21, Winston & Strawn LLP

2 Speaker Simon Luk Chairman, Asian Practice 2013 Winston & Strawn LLP 1

3 Speaker 沈永熙 <Shen yongxi> Senior Partner Major: VC\ PE\ major controversies\ IPO&RTO\ A&R EDU : LL.M at China University of Political Science and Law, LLB at Nankai University, China. Work Experience: 2007-pre Dacheng Law Offices, Senior Partner and Attorney at Law 2010-pre Dacheng Law Offices (New York), Senior Partner 2011-pre Dacheng Wong Alliance LLP, Senior Partner Dacheng Central Chambers LLP, Senior Partner Jiade Law Offices, Founder and Attorney at Law King & Wood, Attorney at Law. Address: yongxi.shen@dachenglaw.com Tel: Winston & Strawn LLP 2

4 Background for Investment in China Capital reallocation from developed countries to China mostly via private equity and cross-border mergers and acquisitions More than 7% growth in China s GDP annually, but less than the central target of 8% Political stability, steady domestic and foreign investment Recent SEC fraud investigations, US stock exchange delistings, securities law class actions and settlements, privatizations of Chinese companies listed in the U.S. Is China s role as one of the factories and R&D centres of the world fading? 2013 Winston & Strawn LLP 3

5 Foreign Direct Investment Capital contributors: Hong Kong, Taiwan, United States Industrial Sectors: manufacturing, telecom Recent examples 2013 Winston & Strawn LLP 4

6 Early Experience Lessons from Hong Kong and Taiwan Since 1980, overseas Chinese from HK and Taiwan have moved their manufacturing base across the border because of cheaper labor then, and availability of land Operated through contractual or equity joint ventures or subcontracting arrangement Examples of transactions 2013 Winston & Strawn LLP 5

7 Direct Investment Between income of U.S. foreign affiliates in China generates considerable earnings Foreign capital reallocation to China (securing control value chain across production operations by acquiring strategic Chinese assets and talents) in: Telecom Semi-conductors Healthcare Financial services 2013 Winston & Strawn LLP 6

8 World Trade Organization and CEPA Officially joined WTO in December 2003: Opened vast opportunities for private equity investments; retail opportunities under CEPA Especially in the growing sectors Particular interest in capital-intensive industries such as chip manufacturing and telecom equipment 2013 Winston & Strawn LLP 7

9 Evaluation of Risks Unreliability of disclosed information and faked financial reporting Centrally planned economy lacks free competition Lack of predictability and transparency in Chinese business environment: Inconsistent interpretation and application of laws and regulations Chinese Government over-protects local firms Foreign enterprises too enthusiastic 2013 Winston & Strawn LLP 8

10 Funding of PE Investments Huge returns to early PE investors in Facebook and Chinese game company Shanda Types of private funding: Seed financing Family and friends Angels Incubation funds Strategic investors and venture capital 2013 Winston & Strawn LLP 9

11 Funding of PE Investments Documents and information required: Executive summary Business description Management team Growing market description Revenue sources Specify proposed investment amount Use of investment proceeds Advantages, time or path to profitability, etc Winston & Strawn LLP 10

12 Funding of PE Investments Business plan Private placement memorandum to contain: Business summary and description Description of target market Explanation of revenue sources and timing of revenue generation Scalability of products and services Capitalization table 2013 Winston & Strawn LLP 11

13 Funding of PE Investments Financial statements and projections should be reasonable but conservative Risk factors Description of competition Management profiles Strategic parties beneficial ownership table Path to profitability Use of proceeds and projected marketing/operating costs, cash burn Exit timing/exit format 2013 Winston & Strawn LLP 12

14 Funding of PE Investments Differences between a Business Plan and PPM: Business plan is primarily a selling tool PPM explains the business and protects the founders by highlighting risk factors PPM contains securities law disclaimers More detailed projections When to use which document 2013 Winston & Strawn LLP 13

15 PE Due Diligence Confidentiality Agreement Protects confidential nature of target's information Sets rules for due diligence Who may receive the confidential information, e.g., only employees/agents with a "need to know" and who have agreed to be bound by the confidentiality agreement Limits investor's contact with target, avoids business disruption, employee panic, and customer/vendor defections Return of confidential information No solicitation or hiring of target's employees 2013 Winston & Strawn LLP 14

16 PE Due Diligence Letter of Intent/Term Sheet: Memorializes parties' general agreement helps avoid misunderstandings or "changes of heart" May reveal irreconcilable disagreements May make transaction cheaper, but could become timeconsuming and the deal may become stalled Often contains target's exclusivity covenant, no shop May contain investor covenant not to solicit employees or customers of target 2013 Winston & Strawn LLP 15

17 PE Due Diligence DD Purposes Gather general industry, market, competition, management information Better understanding of the target, its business, assets/liabilities Identify risks, potential issues impacting investment cost Guidance for drafting and negotiation of investment agreement Verify disclosure schedules Identify closing conditions Identify matters for indemnification 2013 Winston & Strawn LLP 16

18 PE Due Diligence Types of due diligence Legal: contract review, litigation, lien, judgment searches Environmental; accounting/tax Employee benefits; insurance, coverage and claims history Real property, title and surveys; intellectual property: patent, trademark and copyright searches Foreign Corrupt Practice Act review Due diligence request list Define target to include all subsidiaries, including predecessors Open-ended, all-encompassing diligence requests vs. more focused, target-specific diligence requests 2013 Winston & Strawn LLP 17

19 PE Due Diligence Legal & Compliance Target s corporate structure? How long has it been structured? Proper PRC governmental approvals? Is target s business subject to any contingent liabilities? Litigation claims; governmental investigations, FCPA issues, audits or claims for labor and employment; environmental; health & safety; antitrust; securities; criminal investigations Tax audits or disputes; intellectual property claims (Apple vs. Samsung) Insurance coverage disputes Shareholder, employee, customer, or supplier disputes 2013 Winston & Strawn LLP 18

20 PE Due Diligence Legal & Compliance Is target subject to any change of control payments to management, creditors or any other party? Is target subject to any contractual restrictions affected by the transaction? Any non-assignability or change of control restrictions in target's major contracts with customers and suppliers, labor agreements, debt instruments, joint venture agreements, governmental authorizations, retirement plans, noncompete provisions with suppliers, customers, equity holders, or partners, debt incurrence or other structuring limitations in material agreements 2013 Winston & Strawn LLP 19

21 PE Due Diligence Legal & Compliance Is target or investor required to gain approvals to enter into transaction? Estimated time needed for approval Approvals from: Governmental agencies Right of first refusal etc. in shareholders' agreement Shareholders and percentage required Employee matters Employment agreements Any standard confidentiality, non-compete, or non-compliance agreements in place? 2013 Winston & Strawn LLP 20

22 PE Investor s Preferential Rights Principal Rights of Preferred Stock: Types of investment: common stock, preferred stock, convertible preferred stock or convertible preferred debt Valuation issues Dividends may not exist or may not be paid currently or accrue, typically 8% to 12% annually Liquidation preference, the preferred investors will get their money back first 2013 Winston & Strawn LLP 21

23 PE Investor s Preferential Rights Conversion right: Convert at holder s option into common stock The conversion ratio/price is generally subject to adjustment if the issuer later issues securities at a lower price, price anti-dilution protection Preferred stock or convertible preferred debt automatically converts into common stock immediately prior to a qualified IPO 2013 Winston & Strawn LLP 22

24 PE Investor s Preferential Rights Voting Rights Preferred stock or convertible preferred debt generally can vote with the common stock as one class on an as-converted basis Preferred stock or convertible preferred debt has special class voting rights with respect to certain matters Redemption Preferred stock or convertible preferred debt often will be subject to mandatory redemption by the issuer if the issuer has not been sold or gone public within five years after the financing Winston & Strawn LLP 23

25 PE Investor s Preferential Rights Other preferential rights: Preemptive right to purchase pro rata portion of new securities Right of first offer or refusal on sale of founders shares Co-sale rights Right to have one or more representatives on the board of directors Information rights Demand rights Piggyback rights 2013 Winston & Strawn LLP 24

26 PE Legal Issues Employment Related Issues No employment contract Failure to pay overtime compensation Under-payment of social insurance and other employee benefits 2013 Winston & Strawn LLP 25

27 PE Legal Issues Anti-trust Filings The Ministry of Commerce is responsible for the anti-monopoly review Anti-monopoly review is required if an acquisition of a domestic enterprise by a foreign investor constitutes industry concentration Industry concentration: The combined global turnover of the acquirer(s) and acquiree(s) in the previous fiscal year exceeds Rmb10 billion, and the respective turnover in China of at least two parties in the acquisition in the preceding fiscal year exceeds Rmb400 million 2013 Winston & Strawn LLP 26

28 PE Legal Issues Anti-trust Filings Industry concentration con t: The combined turnover of the acquirer(s) and acquiree(s) in China in the previous year exceeds Rmb2 billion, and the respective turnover in China of at least two parties in the acquisition in the preceding fiscal year exceeds Rmb400 million 2013 Winston & Strawn LLP 27

29 Foreign Investors Strategic Investment in PRC Listed Companies A PRC listed company is not permitted to issue its shares to a foreign individual; however, it can issue shares to a foreign company pursuant to Administrative Rules on Foreign Investors Strategic Investment in PRC Public Companies jointly promulgated by several PRC government authorities in 2006 Such share issuance requires approvals from the Ministry of Commerce and China Securities and Regulatory Commission 2013 Winston & Strawn LLP 28

30 Foreign Investors Strategic Investment in PRC Listed Companies con t Requirements with respect to the foreign strategic investor ( FSI ) FSI is duly established and validly existing with stable financial performance, good credit, and mature management experience FSI has established healthy corporate governance and good internal control system FSI shall own offshore assets of minimum US$100 million or manage offshore assets of minimum US$500 million FSI has not been subject to any material penalties imposed by any PRC or foreign regulatory agencies 2013 Winston & Strawn LLP 29

31 Foreign Investors Strategic Investment in PRC Listed Companies con t Transaction requirements The shares issued to the foreign strategic investor shall not be less than 10% of the PRC public company s total outstanding shares There is a three-year lockup period for the shares received from the PRC public company FSI s investment in the PRC public company shall comply with the PRC foreign investment catalogue 2013 Winston & Strawn LLP 30

32 Foreign Investors Strategic Investment in PRC Listed Companies con t Transaction requirements con t When a PRC public company conducts an acquisition with its shares as consideration, it is required to enter into a compensation agreement with the acquiree, who is obligated to compensate the PRC public company for any difference between the projected earnings and the actual earnings in the three years after the completion of the acquisition 2013 Winston & Strawn LLP 31

33 PE Legal Issues PRC Secrecy Law The Securities and Exchange Commission in December 2012 began administrative proceedings against the China affiliates of the Big Four accounting firms and BDO for refusing to produce audit work papers related to China-based companies under investigation by the SEC for potential accounting fraud against U.S. investors Winston & Strawn LLP 32

34 PRC secrecy law con t State secrets defined--information and matters relating to national security and interests and that are only permitted to be available to limited number of people within a limited period of time. The following are state secrets if the leakage or disclosure of such may damage Chinese national security and interests in the areas of politics, economy, state defense and foreign affairs: Classified matters involving the key policy decisions on state affairs Classified matters involving the national defense construction and armed forces activities 2013 Winston & Strawn LLP 33

35 PRC secrecy law con t Classified matters involving the diplomatic and foreign affair activities and classified matters involving the state s international obligation of secrecy Classified matters involving the national economic and social development Classified matters involving science and technology Classified matters involving the activities of maintaining national security and investigating criminal offences Others classified matters as determined by the state secret administrative agency 2013 Winston & Strawn LLP 34

36 Restructuring Legal Issues: SAFE Notices How do the various SAFE notices affect a typical redomicile? Jan 24, 2005 SAFE circular (no. 11) April 8, 2005 SAFE circular (no. 29) October 21, 2005 SAFE circular (no. 75) May 29, 2007 Operating Procedures to clarify no. 75 Approval for overseas investment by Chinese residents Earlier halting of approval and examination by local SAFE 2013 Winston & Strawn LLP 35

37 Foreign-funded Mergers and Acquisitions of Domestic Enterprises General Application applies to domestic companies, enterprises and natural persons (round trip investment) Article 11 requires Ministry of Commerce examination and approval Article 29 permits use of equity of listed overseas company as consideration 2013 Winston & Strawn LLP 36

38 Some proposed structures Creative options Slow Walk structure Variable Interest Entities, VIE structure, questioned in Shandong Province, China recently Option to purchase employee stock option Uncertainties and Risks Current issues and creative thinking? 2013 Winston & Strawn LLP 37

39 Other China PE Issues State assets purchased in an auction? Relevant regulations Applicability of Provisional Regulations on Administration of Transfer of Enterprise State-Owned Property Rights Effect of Chinese judicial procedures on validity of auctions not complying with Chinese regulations Other irregularities in the auctions 2013 Winston & Strawn LLP 38

40 Other Issues Formation of a WOFE using acquired assets: Article 15 of the Pilot Rules on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors Additional documents needed: Chinese seller s resolutions to sell assets, WOFE application letter, WOFE articles of association, translated asset sale agreement, Chinese seller s articles of association, Chinese seller s notices to creditors, investor s documents, and Chinese seller s plan to lay off its employees, as applicable 2013 Winston & Strawn LLP 39

41 Other Issues Shareholder loans: Inter-company loans Individual loans Conversion of shareholder loans into registered capital Land Issues All land belongs to the State Allocated land v. granted land 2013 Winston & Strawn LLP 40

42 Exit Strategies: Mergers and IPOs Exit by sale or merger: Part of a larger organization Tax considerations Cash vs. stock Stock vs. assets Continuing role of management 2013 Winston & Strawn LLP 41

43 Mergers and IPOs IPO exit with follow-on offerings: start planning in advance, decisions involving accounting matters, decisions relating to management retention, selection of professionals Alternative fund raising: reverse takeover of a listed shell not viable in the foreseeable future for Chinese companies Universal shelf registration, registered direct, and follow-on offerings 2013 Winston & Strawn LLP 42

44 Mergers and IPOs Advantages Access to public equity markets will generally enable companies to secure: Better valuations Less dilution than private equity Avoid interest costs, cash drain, and operating and current restrictions associated with debt financings 2013 Winston & Strawn LLP 43

45 Mergers and IPOs Increased options for future financing Currency for acquisitions Enhanced reputation and visibility Enhanced liquidity for investors Incentives for management and employees 2013 Winston & Strawn LLP 44

46 Mergers and IPOs Disadvantages of public offerings: Loss of confidentiality Increased expenses Considerable management time associated with the IPO process and periodic disclosures thereafter Dilution of current ownership and potential loss of control Registration process can be lengthy, and Price volatility 2013 Winston & Strawn LLP 45

47 Mergers and IPOs Other consideration re public offerings: Lock-up arrangements Company's profits must be shared with outside owners Continuous reporting obligations and regulatory requirements Legal liability, Rule 10b-5 liability for false or misleading statement of material facts in any offering memorandum or SEC filings Expenses 2013 Winston & Strawn LLP 46

48 Successful Strategy China market remains to be tapped With the right people and structure, devise a winning strategy Accommodate different needs Not an easy task; delicacy of a diplomat and skill of a mathematician 2013 Winston & Strawn LLP 47

49 2013 Winston & Strawn LLP 48

50 The Protection of Foreign PE Investors In China 2013 Winston & Strawn LLP

51 Introduction Reasons of PE disputes Features of PE disputes Limitations and problems of resolving PE disputes by suits or arbitrations overseas Methods to protect the rights and interests of foreign PE investors in China 2013 Winston & Strawn LLP 50

52 Part one Introduction 2013 Winston & Strawn LLP 51

53 As s new comer in China, PE of considerable distinguishing features and advantages has developed strikingly in China, and causes troubles frequently. In the case that disputes occurred, foreign investors always resort to litigation and arbitration abroad. However, it seems impossible for them to protect their interests thoroughly Winston & Strawn LLP 52

54 Part two Reasons of PE Disputes 2013 Winston & Strawn LLP 53

55 I. Fake statements and guarantees of domestic corporations founders. II. De facto controllers of domestic corporations divert, invade and occupy property of corporations Winston & Strawn LLP 54

56 III. Connected transactions managed by de facto controllers damage interests of domestic corporations. IV. De facto controllers of domestic corporations refuse to return de facto control Winston & Strawn LLP 55

57 V. PE investors are hardly able to exercise their rights to hear from domestic corporations. VI. De facto controllers of domestic corporations refuse to carry out the Ratchet terms Winston & Strawn LLP 56

58 Part Three Features of PE Disputes 2013 Winston & Strawn LLP 57

59 Four Features of PE Disputes Lacks of adequate domestic legal basis and judicial precedents. Diversities and complexities of the model of investments and the frame of stocks. Laws of several nations are involved in one dispute. The process of solving disputes is complex Winston & Strawn LLP 58

60 PART FOUR Limitations and Problems of Overseas jurisdictions 2013 Winston & Strawn LLP 59

61 I. Foreign courts judgments, relevant orders of provisional and preservation measures are usually not recognized or enforced in China. II. Besides, there are circumstances ruled in the Civil Procedure law showing that China can refuse to recognize and enforce certain judgments of foreign courts Winston & Strawn LLP 60

62 III. Courts of foreign arbitral authority could not preserve property and evidence of two parties in China. IV. Related obligees can not directly take over corporations in China according to relevant orders made by foreign courts 2013 Winston & Strawn LLP 61

63 Case: Danone appointed KMPG as receiver to take over assets of Wahaha in Without a permission of a people s court of China, KMPG just took up activities of taking over. In 2008, the court of the second and final instance judged that KMPG acted against the principle of national judicial sovereignty, invaded the sovereignty of Chinese jurisdiction and should extend a formal apology in public as the requirement of the judgment Winston & Strawn LLP 62

64 V. Even if the PE investors win suits or arbitrations, it is still impossible to take control of the invested corporations Facts and Reasons: Valued occupations, such as legal representatives, directors of operation, chief financial officers and so on, are usually in the control of the previous legal representative, and so are important signatures and documents like official seals, data and bank accounts Winston & Strawn LLP 63

65 Part Five Methods to Protect Lawful Interests of Foreign PE Investors in China 2013 Winston & Strawn LLP 64

66 I. Applicable non-legal action II. Civil suits III. Criminal report 2013 Winston & Strawn LLP 65

67 Applicable non-legal actions Renew directors, supervisors and other senior executives of the domestic corporation through its inner procedure and complete the formalities of business change. Take measures to control the important stuff, including official seals, the copy of business licenses of the corporation and the financial documents like accounting books Winston & Strawn LLP 66

68 Civil Suits I. the shareholders right to be informed II. returning the official seals, financial accounting books Law suits of III. the damage of the directors, supervisors and senior executives IV. the removal of obstacles V. dismissing corporations VI. representatives of shareholders 2013 Winston & Strawn LLP 67

69 2013 Winston & Strawn LLP 68

70 2013 Winston & Strawn LLP Thank You.

71 2013 Winston & Strawn LLP Questions?

72 Criminal Report Report the defendant's alleged infringements to the police. According to Criminal Law of the People s Republic of China, the former de facto controllers may be involved in the crime of diverting fund, duty encroachment, contract fraud, financial fraud, feigned capital contribution, capital flight and so on Winston & Strawn LLP 71

73 About Winston & Strawn Award-winning and renowned international law firm Nearly 1,000 attorneys among 15 offices in the USA, Europe & Asia Notable Corporate M&A: High-end Capability (International Firms) China Chambers and Partners, 2012 Recognised Corporate (Including M&A) practice: Foreign Firm Beijing, Shanghai offices Legal 500, 2013 Recognised Corporate (Including M&A) practice Hong Kong Legal 500, 2013 M&A Deal of the Year China Business Law Journal, Winston & Strawn LLP 72

74 Our Global Reach 2013 Winston & Strawn LLP 73

75 Winston & Strawn Contacts: Asia Transactions Hong Kong Simon Luk, Transactional & Finance: ; Beijing Jem Li, Transactional & Finance: ; Shanghai Laura Luo, Transactional & Finance: ; Brinton Scott, Transactional & Finance: ; Bertrand Theaud, Transactional & Finance: ; Chicago Oscar David, M&A & Securities: +1 (312) ; Brian Kozlowski, Private Equity: +1 (312) ; New York Brad Vaiana, Private Equity: +1 (212) ; San Francisco James Topinka, M&A & Securities: T: +1 (415) ; 2013 Winston & Strawn LLP 74