Foreword:
Foreword:
When it comes to the listing of Chinese companies overseas, familiar and unfamiliar terms such as VIE structure, red-chip model, No. 10 document, and Sina model are inseparable. Dakang these capital legends of the last century.
On October 9, 1992, Brilliance Automobile was listed on the New York Stock Exchange in the United States, which opened a precedent for Chinese companies to be listed outside China. On February 17, 1999, Qiaoxing Global, the largest fixed-line telephone manufacturer in China at that time, landed on NASDAQ in the United States and became the first private enterprise listed overseas. Immediately afterwards, the three major Internet portals Sina, Netease, and Sohu, as well as China.com, listed on NASDAQ in the United States with the Sina model of VIE structure. On December 9, 2003, with the successful landing of Ctrip on NASDAQ, it opened the second wave of overseas listing of Chinese Internet companies. Since then, Internet giants such as Shanda, Tencent, 51job, Baidu, and Alibaba have all , towards the overseas capital market.
So what exactly are red chips, VIEs and SPACs? Let's find out with this article:
1. Red chip model and VIE structure
The "red" in the "red chip model" refers to companies whose main business or operations are in mainland China. They transfer domestic assets or interests to offshore companies registered overseas through acquisitions or agreement control (VIE), and then A listing model in which domestic assets or equity are held through overseas offshore companies, and then applied for listing on overseas exchanges in the name of overseas companies.
By setting up a holding company overseas, injecting the assets or interests of domestic enterprises into the overseas holding company, and raising funds by listing overseas in the name of the overseas holding company, this kind of company or enterprise structure is called "red chip structure". The main body of big red chips is state-owned enterprises, and the main body of small red chips is private enterprises.
The red-chip structure is mainly divided into two types, one is the round-trip acquisition or round-trip investment model, and the other is the VIE agreement control model.
The return acquisition mode is that the actual controller of the domestic enterprise establishes a special purpose vehicle (Special Purpose Vehicle, SPV) in the tax haven of the offshore center (usually the Cayman Islands, Bermuda Islands or BVI) in the name of the individual, and then buys the relevant equity Or assets to increase the capital and share of SPV, and then return to purchase the equity or assets of domestic enterprises, and use the name of SPV to list on overseas stock exchanges and land in overseas capital markets.
Image source: Graphical Finance
The so-called VIE (Variable Interest Entity) agreement control mode, namely "variable interest entity", agreement control is also called "Sina mode", before 2006, it was mainly used in overseas private placement and overseas listing of Internet companies. Since foreign direct investment in value-added telecommunications companies is strictly restricted, and Internet business is classified as "value-added telecommunications business" in my country's law, smart funds invented the transaction structure of agreement control in order to circumvent these restrictions. With the recognition of GAAP in the United States, the "VIE Accounting Standards" was created specifically for this purpose, allowing the statements of domestic controlled enterprises to be merged with those of overseas listed companies under this framework, which solved the problem of overseas listing statements.
Image credit: ListCo
Under the VIE model, overseas offshore companies do not directly acquire domestic operating entity enterprises, but invest and establish a wholly foreign-owned enterprise (Wholly Owned Foreign Enterprise referred to as WOFE) in China, and sign a series of exclusive control agreements with domestic operating entity enterprises. Provide monopoly consulting, technical services or management services, etc. Domestic entity enterprises pay their profits to WOFE in the form of service fees. At the same time, WOFE obtains voting rights, mortgage rights, pre-purchase rights and management control rights for all equity interests in domestic enterprises through contracts. Because these VIE rights are also called For "protocol control".
Under the traditional overseas red-chip listing model, due to the sudden implementation of the No. 10 document on September 8, 2006, the construction model of other red-chip structures was disrupted, and finally only the VIE model remained.
"Security Token Offering + Red Chip Structure Analysis
In the STO state, the two main models of the red-chip structure can be tried. The first is to use the round-trip acquisition or round-trip investment mode. The first step is to establish a legal company in the United States, and use natural persons or companies different from domestic entities as shareholders for registration. The second step is to prepare a series of legal documents and submit them to the SEC to apply for a legal STO under the guidance of professional lawyers, accountants and financial experts in accordance with the requirements of RegA+, Reg D, Reg S and other US securities rules. The third step is to legally issue ST overseas to raise mainstream cryptocurrencies (such as BTC, ETH, USDT, etc.). The fourth step is to exchange the raised cryptocurrency into legal currency through overseas legal digital asset exchanges. The fifth step is to invest the legal currency into the domestic entity enterprise in the form of capital increase and share expansion through the holding company established in the legal area (such as Hong Kong, Singapore or Cayman, BVI, etc.) or pay the domestic enterprise by purchasing domestic enterprise services.
The second red-chip structure is to build a VIE overseas, sign a series of monopoly service agreements through the agreement control model, and finally complete the procedure of raising funds overseas."
Building a red-chip structure for overseas STO will face three levels of tax costs. One is the turnover tax (value-added tax (VAT) or commodity consumption tax (GST)) and corporate income tax when the overseas subject company "converts" the cryptocurrency into legal currency after the overseas STO . The second is the value-added tax generated by the related transaction between WOFE in the VIE structure model and the actual operating entity enterprise and the enterprise income tax of the two enterprises. The third is the withholding tax when WOFE remits domestic profits overseas.
——"Ma Hong: Red Chip Structured STO Faces Tax Costs at Three Levels——STO Practical Guide"
2. Characteristics and operation process of SPAC company
In the US stock market, there is a kind of company that they do not have operating assets on hand, and there is no guarantee that they will have in the future. They are essentially empty shells that promise to use the money raised from an initial public offering (IPO) to buy a business. At present, 20% of newly listed companies in the United States each year are listed through this structure. This kind of company is a special purpose acquisition company (Special Purpose Acquisition Company, SPAC).
Beijing O.R.G. Seed Co., Ltd. was the first domestic company to try the SPAC model. In November 2005, the company merged with Chardan China Acquisition, an OTCBB (Over the Counter Trading System) listed company in the United States, and achieved backdoor listing. On November 7, 2018, China Minsheng Financial Holdings Co., Ltd. (00245.HK, hereinafter referred to as “CMFC”) officially announced that the special purpose acquisition company (SPAC) it manages and initiates, China Minsheng Seven Star Acquisition Company (Nasdaq: CMSS, hereinafter referred to as "CMS Seven Stars") will acquire 100% of the issued shares of Kaixin Auto Group for nearly US$454 million. It can be seen that a large number of Chinese companies have entered the US capital market through this model.
The sponsor of the SPAC promises to use the funds raised in the initial public offering (IPO) to acquire an unlisted company with high growth prospects, merge with it, obtain financing and go public. The promoters list this "shell company" on NASDAQ or the New York Stock Exchange, and issue a combination of ordinary shares and stock options in the form of investment units (Unit) to market investors to raise funds. The general value of an investment unit 10 dollars, usually includes 1 common stock and 1-2 stock options. 100% of the funds raised will be deposited in escrow accounts and invested in fixed income securities, such as treasury bonds. If the merger and acquisition is not completed within 24 months, the SPAC will face liquidation, and 100% of the funds in all escrow accounts with interest will be returned to investors.
In particular, any acquisition by a SPAC must be approved by shareholders. If the shareholders do not approve or the blank check company does not close the acquisition transaction within the stipulated time, the funds raised will be returned to the investors. It is for this reason that companies with no products and no revenue are highly sought after by investors when they go public. If a suitable target company is found, after conducting a series of due diligence, all SPAC shareholders will vote to decide whether to merge with it. If a majority of shareholders agree to the merger, the business would receive the funds deposited by the SPAC investors in escrow accounts, and the SPAC investors would receive a portion of the combined company in return.
Stage 1: SPAC company establishment and listing
1. SPAC Company Establishment
Generally, the company's managers find a sponsor (issuer), and with the help of the sponsor, the management establishes a SPAC company.
2. Submit issuance application documents to the SEC (Securities and Exchange Commission)
1. The company conducts a preliminary meeting with the SEC
The company first prepares questions and relevant materials with underwriters, lawyers and other intermediaries, and then meets with relevant SEC personnel to consult relevant laws, accounting, regulations and practical issues.
2. The company submits a registration form to the SEC
According to the U.S. "Securities Act of 1933", companies must register to issue securities, submit an announcement to the SEC, and disclose information related to the issuance, that is, the registration letter, which includes two parts:
1) Prospectus, the main content includes: cover, summary, company, capital investment, distribution policy, equity dilution, capitalization, financial data summary, management discussion, management and major shareholders, legal proceedings, securities introduction, summary.
2) The registration statement, which mainly includes: underwriting fees, directors' and management's remuneration, the company's unregistered securities, its recent transactions and attachments, and a list of financial statements.
3. SEC review registration statement
When the company submits the registration form as required, an SEC team composed of lawyers, accountants, analysts and industry experts will conduct a thorough review and verification of all the contents.
4. The SEC issued its first opinion letter
Under normal circumstances, the registrant will receive the first opinion letter from the SEC 4-6 weeks after the first submission of the report, which is mainly the SEC's inquiry about the company's situation, so as to help the company improve the registration form.
The content mainly involves:
1) What is the current situation, business, products and services of the company;
2) Whether information such as the development, production, marketing and distribution satisfaction of new products have been disclosed;
3) Whether the background and experience of management personnel are false or not fully disclosed;
4) Whether all related transactions are fully disclosed;
5) Whether the management's analysis and discussion of the business is sufficient;
6) It is necessary to explain the disclosure of financial statements and add risk factors.
5. Amendment of registration certificate
According to the SEC's opinion letter, the company revises and improves its registration form.
6. SEC review registration certificate
The SEC will review the company's resubmitted registration form to determine whether the company's information disclosure is appropriate. If the SEC believes that the revised documents still do not meet the requirements, it will issue a bedbug letter, recommending that the registrant withdraw the registration, or issue a suspension order; if the document is considered to be basically qualified, the intermediary agency will be required to bear corresponding legal responsibilities; if it is still necessary to amend, Revised instructions will be issued again.
7. The SEC issued a suspension order or passed
If the SEC issues an order to suspend the effectiveness of the registration statement, it means that the company shall not be listed; if the SEC does not make any comments on the revised registration statement, it means that it is passed, and the registration statement will automatically take effect within 20 days.
8. Review by NASQ (National Securities Exchange Association)
NASQ mainly reviews the content of the registration form and the underwriter's commission based on Regulation S—K (the "Regulations on the Content and Format of Financial Information Disclosure" issued by the SEC) to determine whether the underwriter's commission is reasonable, so as to ensure the investment of the general public interests of the recipient.
3. Roadshow to investors
As an important promotion means to promote the successful issuance of stocks, Road Show has promoted the full communication between investors and securities issuers.
Stage 2: The target company goes public through a reverse merger of the SPAC company
SPAC listed on NASDAQ or NYSE (IPO)
- The management of the SPAC needs to find the target company and complete the merger within 24 months;
－SPAC management due diligence on target companies;
－The SPAC company and the target company determine the merger plan;
- Roadshow to shareholders;
- The SPAC shareholder meeting votes to approve the merger;
- The merger of the newly listed company was completed and its name was changed, and the new company was officially listed on the main board of the United States;
－Newly listed companies traded on the main board and obtained secondary financing.
3. Potential investment opportunities under the SPAC structure
For ordinary investors, SPAC is a product that may have options. To put it simply, options mean that the downside is limited, but the upside is huge.
When there is no acquisition information, the SPAC is essentially a cash shell company, so the stock price should be equal to its net cash value, otherwise there will be room for arbitrage. However, when a SPAC buys a company, its stock price can become very volatile, with the stock price fluctuating based on the quality of the company being acquired. If it is a good deal, the stock price will rise sharply, and if it is a bad deal, the stock price will fall sharply.
SPACs have an extremely important statute: Shareholders vote on whether the eventual merger is completed. If the management wants to buy a bad company, SPAC shareholders have the last insurance, voting against it. Therefore, if the bad deal is voted down, the worst outcome for such a SPAC enterprise is to be liquidated with a net cash value of $10. If the management can find a good investment opportunity, then the stock price may rise by 50%, 70% in a short period of time. If the SPAC has a very savvy shareholder, then the worst outcome of the SPAC is $10 per investment unit, but the possible increase is very large. Therefore, the core of investor strategy is to follow the savvy major shareholders.
4. Suitable enterprises and arbitrage opportunities of SPAC
SPAC is suitable for private small and medium-sized enterprises in China, and helps medium-sized Chinese companies that lack cash to achieve overseas financing and overseas listing.
Typical features:
1) Nature of enterprise: Private
2) Industry: IT, consumer electronics, new materials and new energy, biotechnology, or other characteristic industries
3) Enterprise status: segmented industry leader, high growth, high market share
4) Profit requirements: net profit > 40 million RMB/year (profit is not a rigid requirement, mainly evaluated by the company's market value)
5) Law: legally taxed and legally operated enterprises
The Chinese concept SPAC can provide investors with an arbitrage opportunity to obtain excess returns. This is because: the SPAC screens the target company and completes the merger after the issuance of equity units. If the value of warrants among equity units is too high, the price of common shares will definitely be lowered, creating a certain arbitrage space for obtaining excess returns. This may be explained by the principle of "high risk, high return", but as long as a SPAC can acquire a suitable company and realize the transition from the private equity market to the public equity market, it can generally bring higher returns.
However, for enterprises, the SPAC model also has inherent risks. After being listed or promoted, SPAC funds generally choose to exit. There are many companies that have too many shares in the hands of the fund. After the fund exits, if no new funds come in, the company will die. Therefore, although the company is listed overseas, it will be found that after the first financing, there is no way to conduct the second and third financing, thus losing the financing ability. Therefore, enterprises need to balance and be cautious when conducting equity financing in the international capital market.
References:
References:
SPAC: Interpretation of the New Ways of Overseas Financing for Chinese Enterprises Wu Lei Yang Xiaodong (School of Economics, Nankai University, Tianjin 300071)
Ma Hong: Red-chip structure STO faces three levels of tax costs——STO practical guide
60-page PPT | One article explains the construction, dismantling and red-chip return of the VIE structure!
New ways for Chinese companies to go public in the United States and SPAC innovative financing and listing methods
A new option for going public in the US — SPAC!
