The main objective of a buyout fund is to secure control of an enterprise during its growth or mature phase before increasing its value through a restructuring or other such means. Perhaps, from the perspective of supply side structural reforms, the indirect participation in the mixed-ownership reform of SOEs through buyout funds will become the best route for private capital.
Operating model. Currently, the participating entities in Chinese buyout funds are mainly divided into securities house direct investment focusing on acquirers, private equity (PE) firms focusing on projects, and listed companies targeting the industry. Among them, the most mature model is one where a listed entity and a PE firm jointly establish a buyout fund as a partnership or a company.
The mixed-ownership reform of SOEs not only includes cross-shareholding state-owned capital and private capital, but also comprehensive reform, including industry integration, corporate governance, etc. The model in which a buyout fund participates in the mixed-ownership reform of a SOE can be upgraded to an operating method with three parties, namely state-owned capital plus listed company plus PE firm, serving as sponsors. The injection of state-owned capital can attract more private capital, mitigating funding pressures; the participation of a listed company prevents the tying up of excessive own funds, avoiding the triggering of a material asset restructuring, such that regulatory limitations can be surpassed and, based on its market transparency and integration capabilities, the listed company can assist the government in realizing its industry layout earlier; and, with the credit enhancement provided by the state-owned capital and the listed company, the PE firm can fully leverage its advantages in fundraising, post-investment management, value enhancement and locking in of a divestment channel in advance.
One of the specific methods involves a PE firm or special-purpose vehicle (SPV), as the general partner (GP), and the state-owned capital, listed company and private capital, as limited partners (LP), establishing a fund in the form of a partnership. The fund manager (usually a PE firm), together with the LP, establish an investment decision-making committee to manage the operations of the fund. Additionally, the party contributing the state-owned capital may retain veto power on the investment decision-making committee.
The second method involves the state-owned capital, listed company, PE firm and private capital jointly establishing a fund-management company, and, in the specific process of projects, a new SPV needs to be set up, in which the PE firm serves as GP, and shareholders outside the PE firm could inject funds to the SPV to realize the investment.
Operational method. The main ways for a buyout fund to acquire equity are through equity transfers and capital/share increases, but there are other means, such as subscribing to convertible bonds and debt-for-equity swaps, etc. Based on the percentage of the equity of the proposed target enterprise held, buyout funds can be divided into controlling buyout funds and participating buyout funds.
A controlling buyout fund realizes resource integration, restructuring and optimization by obtaining control of the target enterprise and securing the right to make the decisions on integration after acquisition. State-owned group enterprises and platform operating companies can take on controlling buyout funds to achieve the objectives of bringing in private capital and improving their equity structures by procuring the listing of their subsidiaries after their restructuring or integration thereof.
Participating buyout funds provide capital support for target companies mainly through equity or debt financing, and their objective is not control of such entities. When a Tier 2 or lower level entity in a state-owned group company carries out equity diversification reform at its level, it may opt to bring in a participating buyout fund to obtain value-added services.
Matters requiring attention. Firstly, the issue of the GP and connected parties. Pursuant to the Partnership Law, a wholly state-owned company, SOE, listed company, public welfare institution or association may not serve as a GP. Additionally, pursuant to the Stock Listing Rules, steps should be taken to avoid the buyout fund becoming a connected party of the listed company.
Secondly, the issue of employees of an SOE holding equity in lower level subsidiaries. The Opinions on Regulating the Equity Holdings and Investments of Employees of State-Owned Enterprises and the Notice on Issues Relevant to the Implementation of the Opinions on Regulating the Equity Holdings and Investments of Employees of State-Owned Enterprises restrict the holding by employees of SOEs of equity in their enterprise and subsidiaries at any level. In practice, the issue of employees of the SOE participating in the establishment of a fund management company or a co-investment project need to be comprehensively considered for compliance.
Thirdly, the issue of the transfer of the holding of state-owned shares. At the time of divestment on listing, a state-owned shareholder is required, pursuant to the Implementing Measures for the Transfer of the Holding of State-Owned Shares on Domestic Securities Markets to Top Up the National Social Security Fund, to transfer 10 per cent of the actual issued shares it holds at the time of the initial public offering of the listed company to the National Council for Social Security Fund. Where the state-owned capital contribution percentage in a buyout fund is greater than 50 per cent or the state-owned investor is its largest equity holder, attention needs to be paid to performing the obligation of transferring the holding of state-owned shares.
Fourthly, the issue of state-owned asset regulation. When a buyout fund participates in the mixed-ownership reform of an SOE, it is additionally required to comply with regulations related to state-owned assets, and implement the principle of guarding against the squandering these. Particularly, in the course of a transfer of state-owned property rights, it is necessary to secure approval from the state-owned asset regulator, carry out valuation of the target assets, carry out the transfer publicly on a property rights exchange or by agreement and complete title registration.
Development trends. As a highly effective method for integrating resources, buyout funds can effectively satisfy the requirements of the mixed-ownership reform of SOEs at the policy and industry levels. Particularly, after the issuance of the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions, buyout funds, with operating methods and risk management systems made more compliant, will, perhaps, draw more interest from state-owned capital and explode the capital markets with their help.
Yang Bin is a partner and Lei Yang is an associate at East & Concord Partners