The rapidly-developing Chinese economy attracts overseas private equity (PE) funds to invest in China. This analysis is a brief introduction to some of the issues that arise when overseas PE funds make pre-IPO equity investment in PRC companies. For example, pushing an invested company to be converted into a company limited by shares and listed in China's A-share market has become an exit mode accepted by overseas PE funds.
Excerpt:
Arrangement of Fixed Returns
In accordance with current PRC Company Law (Company Law), if the PRC company in which an overseas PE fund invests is an equity joint company with limited liability (EJV), the shareholders of the EJV can distribute the dividends in accordance with the agreed proportions.
In accordance with the Implementing Rules of the PRC Sino-foreign Co-operative Joint Venture Law, if the PRC company invested by an overseas PE fund is a cooperative joint venture company (CJV), it is allowed to increase the portion of foreign investors in proceeds distribution pursuant to the cooperative joint venture contract.
As such, it is viable under current PRC law if it is agreed that overseas PE funds are entitled to more dividends than those in terms of their equity proportions under the foregoing two scenarios. However, we would like to draw your special attention to the following: if it is agreed that overseas PE funds are entitled to fixed returns provided by the invested company, then that would be possibly unacceptable under current PRC law. The essential difference between the two arrangements is that, the arrangement under which overseas PE funds are entitled to more dividends than those in terms of their investment proportions is still made on the basis of the basic principle that the shareholders of the company take joint risk on profit or loss of the company, and if the invested company is run at loss, none of its shareholders will receive any dividends. However, under the fixed returns mode, the investors will receive their relevant returns regardless whether or not the invested company is profitable. That is in violation of the basic principle that the shareholders should take joint risks on profit or loss of an invested company and will possibly neither be accepted by the relevant authority of foreign investment nor be upheld by a PRC court in case of dispute.