At present, China governments put more and more off-limits on acquisition of domestic enterprise by foreign investor. Such kind of acquisition should comply with not only regulations regarding merger & acquisition, but also the laws and regulation regarding anti-monopoly and economic security review. Clearly, the aforesaid complicate examination and approval procedure increase uncertainty of the transaction. As such, more and more Chinese companies would like to take approach of offshore structure acquisition.
Typical Structure of an Offshore Acquisition
Under a typical structure of an offshore acquisition, PRC seller: 1) owns equity interest in a purely domestic limited liability company (“LLC”); 2) then sells equity interest in LLC to offshore special purpose vehicle ( “SPV” ), which was established by PRC seller; 3) then sells shares in offshore SPV to foreign buyer.
Pros of Foreign Investor choosing Offshore Acquisition
The offshore structure acquisition has the following advantages:
1) for the seller, the offshore acquisition helps them to receive payment offshore and achieve tax savings purpose, and there is no PRC government approval required ;and
2) for the buyer, they will have more flexibility in deciding structuring terms, including payment, and the offshore structure acquisition will also shorter completion time.
Impact of the Rules on Acquisition of Domestic Enterprise by Foreign Investor on the offshore structure acquisition
Article 11 of the Rules on Acquisition of Domestic Enterprise by Foreign Investor (“M&A Rules”), which took effect in September 8, 2006(“Effective Date”) , stipulates that if a PRC domestic company, enterprise or natural person intends to acquire an affiliated domestic company in the name of an overseas company lawfully established or controlled by it/him/her, it/he/she should report the same to the Ministry of Commerce (“MOFCOM”) for examination and approval; However, in practice, there is no precedents of MOFCOM granting approval for affiliated acquisition. That means, if PRC seller sells equity interest in LLC to offshore SPV(which was established or controlled by PRC seller) after Effective Date of M&A Rules, MOFCOM will not grant approval on such transaction and then the offshore structure acquisition would be broken down due to lack of MOFCOM approval.
New options to conduct offshore acquisition
In practice, in order to circumvent Article 11 of M&A Rules, lawyers and investors have developed four options to conduct offshore acquisition, which are:1) pre-Sep 2006 offshore structure acquisition; 2) VIE(“variable interest entity”) structure acquisition; 3) “convert LLC to FIE first” structure acquisition ; and 4) “creeping” acquisition. VIE structure acquisition is the most common structure adopted by Chinese company.
Normal
Steps of VIE Structure Acquisition
VIE structure acquisition is commonly found in industries with foreign equity participation restrictions or investor qualification requirements. Normally, the steps for VIE acquisition are:
1) PRC founders set up LLC in the RPC in which PRC founders owns equity interest;
2) PRC founders establishes an offshore company(the so-called SPV);
3) This offshore company sets up a WFOE( Note: in order for the offshore company to set up a WFOE in China, PRC founders should carry out SAFE Notice 75 filing);
4) Forging investor invests in offshore company; and
5) WFOE controls and extracts profits from LLC(owned by PRC founders, as advised in Step 1) through a set of contractual agreements;
The following diagram shows process of a VIE structure acquisition:
(to continue)
Adam Li