Private Equity in China
Private Equity in China
Private Equity Investing in China
Private equity investors are adjusting with onshore investments, as onshore “round-trip” transactions have become more difficult to carry out in China. A new report from an international law firm reveals that although there are still opportunities for private equity investments in China, there are some significant barriers created by the Chinese government.
So-called “round-trip” investments are becoming increasingly difficult to carry out in China. This transaction occurs when an investor places money in an offshore holding company to gain an indirect share in a company located in China. Western investors like “round-trip” investments because they provide several benefits such as common and preferred stock, and valuation adjustments.
Since 2005, however, the Chinese government has been tightening restrictions, making it difficult to establish the offshore entity. According to the report, this has “made private equity deal structuring extremely difficult.” Private equity investors have adjusted by turning to foreign investment enterprises (FIE), usually as a joint venture. FinanceAsia explains how investors are using FIEs:
With regards to capital structures FIEs do not have shares. Instead, an investor’s interest is represented by an undivided percentage of the FIE’s registered capital, the capital paid in by investors. This interest is not freely transferable since a transfer of equity requires not only the approval of the government and the entire board, but for the FIE’s documents to be changed too. Therefore, one recalcitrant board member can scupper any transfer by either refusing to allow the transfer or by not allowing for the relevant documentation to be changed.
A foreign invested company limited by shares (FICLS) is another form of the FIE which Dechert predicts will become a more attractive option for private equity investors.
An FICLS can, in theory, have differing classes of equity, and it is the only FIE that can be listed on the stock exchange, allowing an exit via an initial public offering. Compare this with, say, the inflexibility of equity joint ventures, where equity rights and board representation must be set in accordance with equity percentages.
Private equity firms seeking to exit an investment will prefer the offshore transaction to the onshore:
…the onshore transaction offers fewer options than its offshore equivalent, which can often be concluded without government approval by the sale of the holding company. It might be necessary to sell the foreign-held equity to domestic Chinese investors—an increasingly likely option if the number of renminbi equity funds continues to rise. A listing in Shanghai or Shenzhen might be possible, but this faces significant regulatory hurdles, says the report. This is the route that FIEs are already taking.
The report concludes: “Investors equipped to adapt to transaction and exit structures unique to onshore direct investments will have at their disposal a broader range of alternatives and will be better-positioned than their competitors in a market recovery.”
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Tags: offshore holding company, onshore investments, Private equity asia, Private Equity China, private equity Chinese, Private equity Hong Kong, Private equity in China, private equity investing
