On 30 November 2013, the China Securities Regulatory Commission (CSRC) issued the Notice on Strictly Implementing the Listing Criteria for Initial Public Offerings (IPOs) of Shares When Conducting Reviews of Back Door Listings, which expressly specifies that the back door listing criteria are equivalent to the IPO criteria, and that back door listings are not permitted on the second board. In light of this, some companies have to search for a new back door listing method.
In August 2011, the CSRC issued the Decision on Amending Regulations for the Material Asset Restructuring and Ancillary Financing of Listed Companies, which expressly address back door listings for the first time: “From the date on which the change of control occurs, if the percentage of the total assets purchased by the listed company from the acquirer is equivalent to at least 100% of the period end total assets on the audited consolidated financial and accounting report for the fiscal year before the change in control of the listed company … the business entity from which the listed company purchased the assets shall have been operating as a going concern for at least three years, and its net profit for the most recent two fiscal years shall have been in the black and total more than RMB20 million [US$3.3 million]. Other regulations will be formulated by the CSRC where the assets purchased by a listed company are in a specific industry such as finance, venture capital, etc.
“Once the material asset restructuring specified in the preceding paragraph is completed, the listed company shall be in compliance with CSRC regulations on the governance and compliant operation of listed companies, be independent from its controlling shareholder, actual controller and other enterprises controlled by it in terms of business, assets, finances, personnel, organisation, etc., and there shall be no competition or obviously unfair connected transactions between it and its controlling shareholder, actual controller or other enterprise controlled by it.”
From the foregoing, it can be seen that two factors are key for a back door listing: a change in control and total assets.
To circumvent the foregoing provisions on back door listings, the “first, break up the equity of the target company + consolidation + gradual injection” method may be used. The key is to first disperse the equity of the target company to enable the listed company to utilise accounting consolidation standards to realise consolidation under the circumstance where it holds relatively little of the acquired party’s equity, and then gradually inject the remaining shares into the listed company. This method will not trigger the new provisions for back door listings.
Through a skilful application of the above-mentioned method, the CSRC’s provision against back door listings on the second board can also be circumvented. When actually making use of the above-mentioned method, reference can be made to the following provisions of chapter 2 of the Enterprise Accounting Standards, No. 33: Consolidated Financial Statements (2006).
Article 6. “The scope of consolidation of consolidated financial statements shall be determined on the basis of control. The term ‘control’ means that one enterprise can control the financial and operational policies of another enterprise and, based thereon, secure the right to benefit from the business activities of the other enterprise.”
Article 7. “The holding, by the parent directly, or indirectly through a subsidiary, of more than half of the voting rights in an investee entity indicates that it can control the investee entity, and it shall recognise the investee entity concerned as a subsidiary and include it within the scope of consolidation of its consolidated financial statements, unless there is evidence showing that it cannot control the investee entity.”
Article 8. “Where a parent holds half or less of the voting rights in an investee entity, it shall be deemed to control the investee entity, if any of the conditions set forth below is satisfied, and it shall recognise the investee entity concerned as a subsidiary and include it within the scope of consolidation of its consolidated financial statements, unless there is evidence showing that it cannot control the investee entity:
- holding more than one half of the voting rights in the investee entity through an agreement with the other investors in the investee entity;
- having the right to decide the financial and operational policies of the investee entity pursuant to its articles of association or an agreement;
- having the right to appoint and dismiss the majority of the members of the board of directors or other similar organ of the investee entity; or
- accounting for a majority of the voting rights on the board of directors or other similar organ of the investee entity.”
Article 9. “When determining whether control can be exercised over the investee entity, consideration shall be given to such potential voting right factors as the convertible corporate bonds of the investee entity convertible during the period in question held by the enterprise and other enterprises, warrants that can be exercised during the period in question, etc.”
Financing + acquisition model
With the “private additional financing + asset acquisition” model, namely first making a private additional offering and then using the proceeds to purchase the subject assets that are equivalent to at least 100% of the assets of the listed company, not only can the back door listing review be circumvented, but the substantive objective of restructuring and protecting the shell can also be achieved. In future, this model may become the shell protection method selected by more ST (special treatment) companies.
Article 2 of the Administrative Measures for the Material Asset Restructuring of Listed Companies specifies that “these Measures shall not apply where a listed company, in accordance with the purpose of the proceeds disclosed in the securities offering documents approved by the CSRC, uses the proceeds to purchase assets or invest in a third party”.
The company first purchases in cash a portion of the assets it intends to inject, making sure that their total book value is kept below the level where they would constitute a material asset restructuring, and then offers shares to purchase assets. The two asset purchases constitute two independent events. The assets purchased on the first occasion will, in the course of the restructuring, be exchanged out with the original assets, liabilities and personnel, and are completely unconnected with the equity purchased during the restructuring. In this method, the fund provider may not overlap with the asset provider.
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