A typical PE/VC term sheet normally contains a clause regarding information rights. A PE/VC expects such clause to allow them to have access to the financial statements or information of the target company and therefore ensure their investment return.
A PE/VC term sheet addresses the information rights issue normally in the following way:
A holder of series A preferred shares shall be granted access to Company facilities and personnel during normal business hours and with reasonable advance notification. Upon the request by such holders, the Company shall deliver to such holder(i) annual, quarterly, and monthly financial statements, and other information as determined by the Board; and (ii) thirty days prior to the end of each fiscal year, a comprehensive operating budget forecasting the Company’s revenues, expenses, and cash position on a month-to-month basis for the upcoming year.
However, a foreign PE/VC, which might not be familiar with PRC legal scheme, would make mistake thinking the foregoing stipulation would protect their information rights. Due to Article 34 Paragraph 2 of PRC Company Law, they would walk right into a trap if they address this issue in the foregoing way.
Article 34 Paragraph 2 of PRC Company Law stipulates that if the company has a reasonable ground to believe that the shareholder wishes to review the accounting books for other than legitimate reasons that may cause harm to the company’s lawful interests, it may refuse to provide them for the shareholder’s review and shall give the shareholder a written response explaining its reason within 15 days of the date of submission of the written request by the shareholder.
Thus, the company may use Article 34 Paragraph 2 to fight against a PE/VC requesting to provide the financial statements or other documents.
In order to prevent the company from using Article 34 Paragraph 2 to hang its hat on, a PE/VC may restrict the company’s rights in the clause of protective provision by stipulating that if the company exercise Article 34 Paragraph 2 of the PRC Company Law and refuse the shareholder’s request to review the financial statements or have access to the financial information, the unanimous affirmative votes of all directors of board are required. Given that a PE/VC normally has a right to appoint a director in board of directors, then the PE/VC may count on the aforesaid protective provision to exercise information rights.
By Adam Li