In order to ensure the investment return, a PE/VC normally requests to insert a clause in respect of fixed return into a PE/VC term sheet. Such clause has been commonly adopted in western jurisdiction; however, such clause would be challenged by PRC laws.
In a typical PE/VC term sheet, the clause regarding fixed return should be:
“Dividend: the holders of the series A preferred shall be entitled to receive non-cumulative dividends in preference to any dividend on the common share at the rate of 8% of the original purchase price per annum. The holders of series A preferred also shall be entitled to participate pro rata in any dividends paid on the common stock on an as-if-converted basis. ”
Such clause will be challenged by PRC laws. After a foreign PE/VC acquire equity interest from a Chinese entity in a purely domestic company, the target company will be converted into a foreign-invested enterprise. Thus, the arrangement regarding dividend payment should be governed by PRC laws regarding foreign invested enterprise.
Unfortunately, in 2002, the PRC government has already promulgated the rules regarding dividend payment of a foreign invested enterprise, which prohibit foreign shareholder from receiving the fixed return from the company’s profit on annual basis, as they would believe that the fixed return arrangement would hurt Chinese shareholder’s interest. The PRC government does not yet abolish such rules to the date.
Additionally, the PRC law regarding joint venture also stipulates that the annual dividend of a foreign invested joint venture should be distributed to the shareholders according to their shareholding, which means a PE/ VC is not entitled, as a shareholder of joint venture formed after acquisition, to request the joint venture to pay them the dividend at a fixed rate which is not proportional to their shareholding.
By Adam Li