Many foreign companies are looking to acquire PRC companies to access the Chinese market or expand their Chinese operations. M&A activities in China are divided into two main categories: I) Equity M&A and; II) Asset M&A.

I. Equity M&A

This refers to a transaction where foreign investors purchase by agreement the shares of a Chinese domestic company or subscribe for an increased proportion of the shares in a domestic company.

TYPES OF EQUITY DEAL STRUCTURE

     1.1  Acquisition of a holding directly in a company based in mainland China

Foreign investors may directly purchase shares of the target, either by acquiring existing shares from the seller or by acquiring newly issued shares from the target.

PRC law requires a foreign investor to acquire shareholding of atleast 25% in order to qualify as an FIE and be subject to preferential tax policies. Shareholdings of less than 25% are allowed but would need to go through the process of Ministry of Commerce (MOFCOM) approval which can be cumbersome and will not be eligible for tax preferential policies. In either case, the domestic company is converted into a FIE upon completion of the purchase.

Mainland China’s law of contract and company law provides a precise but not very flexible legal framework. Further, the acquisition of a domestic company in China is subject to extensive administrative controls and cannot be carried out, even when the acquisition contracts have been signed, until the approval of the relevant authorities has been obtained. These authorities are the local branches of MOFCOM, or MOFCOM itself.

1.2 Acquisition of an interest via a holding company based in Hong Kong

Foreign investors may also indirectly acquire the target by purchasing shares in its holding company based in Hong Kong because the latter already holds a subsidiary in mainland China. This way the investors may be able to avoid Chinese government approvals altogether for an offshore deal. Further, Hong Kong provides an ideal platform for carrying out M&A because of the flexibility of its legal and tax rules. There is no capital gains tax on the sale of securities.

1.3 Merger existing Chinese FIE with target

Foreign investor can also consider merging one of its existing FIEs with another company in mainland China, which can be either another FIE or a non-FIE domestic enterprise.  A merger can be an attractive option since it is basically “tax-free”, but the statutory procedures for notifying creditors and obtaining government approvals can take a year or longer to complete.

II. Asset M&A

This is a transaction by which a foreign investor purchases and subsequently operates the assets of a Chinese domestic company. The main advantage of an asset deal is that it can be structured to avoid assumption of the target’s liabilities.

KEY TERMS FOR NEGOTIATION IN A COMMERCIAL DEAL

1.      Basic deal structure

• What is the method of Acquisition? (stock purchase or asset purchase)
• What is being sold? (Related party transactions and “personal” assets)
• What is the purchase Price?
• What is the method of payment?
• Hold-backs/Escrows to secure indemnity?
• Provisions for “Earn-outs” in case of disagreement in price between the parties.
• Assumption of Liabilities/Risk Allocation.

2.      Tax considerations

3.      Risk allocation (liabilities, claims, encumbrances associated with the business)

4.      Apply preliminary due diligence

5.      Calculation of exchange ratio

6.      Provision for exclusivity (no-shop and no talk provisions).

7.      Confidentiality agreement

8.      Any Bridge loans/advances to Target?

9.      Who bears the transaction expenses? (who pays the lawyers, bankers, etc.)

10.  What happens to the acquired company’s employees? (minimum retention, possible terminations, relocation)

11.  Closing conditions and procedure.

12.  Termination provisions: Events of termination and remedies in event of termination.

13.  Anti-dilution issues in cross-border M&A transaction

14.  Governing law: Choice of law/exclusive forum, in case of conflict at the later stage.