Hidden yet Bright - Investment Institutions Seeking Diversified Exit Path: Participating in Major Mergers and Acquisitions of Listed Companies

LABEL： Securities and Capital Markets , Private Equity & Funds , Corporate and M&A ,

Investment institutions (including venture capital firms, private equity funds, industry investments, and other types of investment participants collectively referred to as "investment institutions") have become important participants in market activities through their long-term capital investment methods, promoting direct financing for companies planning to go public and providing important financial support for the development of specific industries. For investment institutions, in the process of "fundraising, investment, management, and withdrawal", project withdrawal is the last mile for their standardized operation and return to investors. For a long time, the mainstream exit path for investment institutions has mainly been through the completion of IPO listing by the invested companies. Since the second half of 2023, a series of new regulations and policies have been introduced in the domestic capital market. Based on current policies, regulations, and market conditions, it is recommended that investment institutions consider diversified exit channels beyond IPOs, and participating in major mergers and acquisitions of listed companies is one of the optional paths.

Recently, we have also received inquiries from multiple investment institutions regarding the possibility of the invested companies participating in mergers and acquisitions to achieve fund exit.

We believe that the current legislation on mergers and acquisitions provides legal basis for investment institutions to participate in transactions. For example, the current "Measures for the Administration of Major Asset Restructuring of Listed Companies (Revised in 2023)" (the "Restructuring Management Measures") stipulate that "investment institutions established in accordance with the law, such as merger and acquisition funds, equity investment funds, venture capital funds, industry investment funds, etc., are encouraged to participate in mergers and acquisitions of listed companies." This provision was first included in the 2014 revision of the "Restructuring Management Measures" and has been retained since then. At the same time, in an important policy document released by the China Securities Regulatory Commission on March 15th, it explicitly supports listed companies to enhance their investment value through mergers and acquisitions, encourages listed companies to comprehensively use tools such as shares, cash, and targeted convertible bonds to implement mergers and acquisitions, and guides trading parties to reasonably determine transaction prices based on market-oriented negotiations. Therefore, whether at the level of laws and regulations or regulatory policies, investment institutions are given the feasibility to participate in this type of transaction. In addition, for companies planning to go public, even if the IPO is rejected, it does not prevent them from participating in mergers and acquisitions of listed companies as target assets while meeting the relevant requirements of the "Guidelines for the Application of Regulatory Rules - Listing Category No. 1" [2]. Shareholders of investment institutions of such companies can also exit through such transactions.

We understand that investment institutions can conduct internal evaluations based on relevant transaction plans, attempt to diversify their exit paths, and consider participating in mergers and acquisitions of listed companies as a feasible option. For most investment institutions, they have witnessed the majority of invested companies achieve IPOs for a long time, and gradually become familiar with relevant laws and regulations, shareholder verification processes, audit focus, and investment management processes after listing. However, for mergers and acquisitions, it is still necessary to understand the relevant transaction paths and audit focus points.

According to the current rules on mergers and acquisitions, listed companies engaged in related asset or equity transactions that meet specific targets, or listed companies issuing shares to purchase assets, are subject to relevant regulations such as the "Restructuring Management Measures". We understand that the path for investment institutions to participate in mergers and acquisitions of listed companies is not complicated, that is, to transfer their equity holdings in the invested company to the listed company, and the listed company will pay the investment institution the consideration for the purchased target assets through issuing shares and/or paying cash; In addition, we have also noticed that some investment institutions are aggressively investing in specific invested companies, and then participating in subsequent M&A and restructuring transactions. We will address issues of concern to investment institutions, such as the audit focus points for mergers and acquisitions through standard transaction pathways. Please understand that, in addition to the standard path of mergers and acquisitions transactions mentioned above, there are certain operational path variants and derivatives of such transactions, such as asset injection after the acquisition of control rights of listed companies, which we will not elaborate on in this article for the time being. At the same time, this article may not exhaust all transaction paths and issues. If necessary, please contact us for further consultation.
1、 Does it constitute a restructuring and listing

Investment institutions participating in mergers and acquisitions should pay attention to whether specific transactions constitute "restructuring and listing" (i.e. "backdoor listing") under the "Restructuring Management Measures". According to the "Measures for the Administration of Restructuring", the following conditions must be met for restructuring and listing: (1) within 36 months after the change or alteration of control of the listed company; (2) During the period of (1), asset injection meets the "five criteria", namely:

 

In addition to the "five standards" mentioned above, the "Restructuring Management Measures" also set corresponding fallback standards, mainly to prevent and avoid other forms of backdoor transactions; If it constitutes a restructuring and listing, according to current regulations such as the "Restructuring Management Measures", its regulatory review standards are equivalent to those of an IPO. At the same time, the regulatory authorities have clearly stated in the regulatory policy released on March 15th that strict supervision will be imposed on "backdoor listing". Therefore, we understand that in order to avoid potential regulatory risks, investment institutions should pay attention to the industry, market value, and relevant financial indicators of the listed company they intend to trade when communicating with the management of the invested company, select appropriate counterparties, and develop a reasonable trading plan.
2、 Cross border mergers and acquisitions

If the invested enterprise of the investment institution has no obvious synergy with the main business of the listed company or is not upstream or downstream of the industrial chain, it may constitute a cross-border merger and acquisition. We observed that there were many similar M&A and restructuring transactions in early A-share listed companies, but due to negative public opinion such as large goodwill impairment, merger and integration risks, and major shareholder stock liquidation in the market, such cross-border M&A gradually declined. For cross-border mergers and acquisitions, according to the relevant policies released by regulatory authorities on March 15th, the regulatory side will strictly supervise blind cross-border mergers and acquisitions. Overall, although the regulation of cross-border mergers and acquisitions has not been relaxed, it seems that it is not impossible. It should comply with regulatory requirements, avoid blind cross-border, and eliminate the situation of "pseudo market value management".

At present, the country is building a multi-level capital market system, and each exchange sector has its own unique sector positioning. For example, the "Shanghai Stock Exchange Major Asset Restructuring Review Rules" stipulate that "if a company listed on the Science and Technology Innovation Board implements a major asset restructuring, the planned asset purchase should comply with the positioning of the Science and Technology Innovation Board, and the industry should be in the same industry or upstream and downstream as the listed company on the Science and Technology Innovation Board, and have a synergistic effect with the main business of the listed company on the Science and Technology Innovation Board." The Shenzhen Stock Exchange also has similar standards for the implementation of major asset restructuring by companies listed on the Growth Enterprise Board that meet the "three innovations and four innovations". We will also continue to monitor the progress of cross-border mergers and acquisitions related to listed companies.

Therefore, we understand that investment institutions should dynamically pay attention to regulatory requirements for cross-border mergers and acquisitions, and when making investment or post investment decisions, they should also consider meeting the requirements of sector positioning for the invested enterprises.
3、 Reasonable transaction consideration

According to the "Restructuring Management Measures", the pricing of the underlying assets is fair. In general, listed companies will hire evaluation and auditing institutions with securities and futures business qualifications to evaluate and audit the underlying assets. Most of them use the evaluation value as the basis for trading pricing. Depending on the different underlying assets, the evaluation methods adopted mainly include asset based method, income based method, market based method, etc. The transaction price is directly related to the investment returns of the investment institution.

According to a rough search through public channels, out of the 25 M&A and restructuring transactions approved in 2023, 16 of them used the income approach as the basis for valuation and pricing, involving 30 underlying assets, of which 25 clearly stated the relevant terms of performance commitments. Among the 25 underlying assets mentioned above, the average P/E ratio of the performance commitment period is between 5 times and 20 times, with the specific distribution as follows:

 

Therefore, we understand that investment institutions can refer to indicators such as price to earnings ratios commonly used in restructuring comparable listed companies or comparable transactions when assisting target companies in negotiating transaction prices with listed companies. This can be combined with the current and future performance of the invested enterprise, the latest round of financing valuation, industry and market, technological or product competitiveness, customer and on hand orders, and other comprehensive evaluations. In addition, the trading consideration is also related to performance commitments/bets, so pricing games are particularly important for investment institutions.

In addition, when investing, investment institutions have certain priority rights to the equity/shares they acquire, and the consideration is usually higher than that of the management or original shareholders. Therefore, whether there is a trading arrangement of the same stock but different prices, we understand that such valuation games can be determined based on specific trading plans, but the overall rationality needs to be demonstrated based on factors such as the obligations undertaken by the investment institution, the length of the lock up period, valuation, and investment costs. In recent mergers and acquisitions, there have been cases of differentiated pricing as follows:

 
4、 Payment form for consideration

The payment method for the transaction consideration of major asset restructuring of listed companies can be full cash consideration, full share consideration, or a combination of share and cash consideration. According to our rough statistics through public channels, the rough statistics of transaction consideration payment methods in the major asset restructuring cases that disclosed their restructuring reports for the first time in 2023 are as follows:

 

Note: The above cases include completed, ongoing, and terminated situations
1. Share consideration

In mergers and acquisitions of listed companies, regulatory authorities do not have mandatory requirements for the weighting of shares and cash consideration. However, if the issuance of shares meets the conditions for small-scale rapid review, the small-scale rapid review procedure can be applied to speed up the review process. In addition, if a specific merger and reorganization transaction intends to raise supporting funds, the scale of such supporting funds should generally be linked to the transaction price of shares as consideration in the issuance of shares, that is, in principle, it should not exceed 100% of the total consideration of such shares.

According to the Measures for the Administration of Restructuring, in general, the price of the issued shares shall not be lower than 80% of the market reference price. The determination method of the aforementioned market reference price is to select one of the average trading prices of the stocks from the 20 trading days, 60 trading days, or 120 trading days before the board resolution of the restructuring plan. The investment institution may calculate the average trading price during this period and further negotiate with the listed company.
2. Cash consideration

The cash consideration for mergers and acquisitions can usually be paid by the listed company through its own funds or self raised funds, including the funds raised through the merger and acquisition ("matching financing"). The payment ability of cash consideration can reflect the cash flow situation of the listed company to a certain extent, and through arrangements such as the payment rhythm of cash consideration, the interests of the target company's management and the listed company can be bound.
3. Consideration adjustment
(1) Stock consideration adjustment in the context of significant restructuring plan adjustments

Under normal circumstances, after appropriate decision-making and disclosure, the parties involved in the merger and reorganization plan will effectively implement it. However, if changes are made to the transaction object, transaction subject, transaction price, etc. of the reorganization plan, and constitute a significant adjustment to the original transaction plan, it will face issues such as re pricing of shares and compliance with decision-making procedures.

According to the application opinions of Article 29 and Article 45 of the Measures for the Administration of Major Asset Restructuring of Listed Companies - Securities and Futures Law Application Opinion No. 15 ("Application Opinion No. 15"), the major adjustments in the restructuring plan mainly include:

 
(2) Share consideration adjustment that does not constitute a significant adjustment to the plan

The "Measures for the Administration of Restructuring" provide a share consideration adjustment mechanism: that is, before registration with the China Securities Regulatory Commission, if the stock price of a listed company undergoes significant changes compared to the initially determined issue price of the consideration shares, the board of directors may adjust the issue price according to the already set adjustment plan. However, this adjustment mechanism needs to be clarified in the restructuring plan resolution of the board of directors of the listed company in advance and should meet the relevant disclosure and verification requirements of "Application Opinion No. 15". In general, such significant changes are measured and determined by selecting relevant market or industry indices, and deviating by a specific percentage point during a specific period or at the end of a trading period. For example, when the following situations occur, it constitutes a significant change: the Shanghai Composite Index (00000 1. SH) or the Specialty Chemicals Index (882409. WI) has a decrease or increase of more than 20% in closing points compared to the trading day before the announcement of the first board resolution of the listed company due to restructuring transactions for at least 30 consecutive trading days prior to any trading day.

In response to the above situation, we suggest that investment institutions and listed companies clearly agree on the relevant transaction consideration and adjustment mechanism (if any), as well as the rights and obligations of both parties in the transaction, such as exclusivity.
5、 Sales restrictions and performance commitments
1. Lock in period

In transactions that do not constitute backdoor transactions, such as investment institutions acquiring shares of listed companies through asset subscription, the lock up period arrangement mainly includes:

(1) Generally, the shares cannot be transferred within 12 months from the date of issuance;

(2) If at the time of acquiring shares of a listed company, the assets used to subscribe for the shares continue to hold equity for less than 12 months, they shall not be transferred within 36 months from the date of the end of the share issuance.

Note: If it involves foreign strategic investment, the provisions of the "Restructuring Management Measures" shall apply to the issuance of shares and purchase of assets in the process of mergers and acquisitions. Therefore, the lock up period shall be implemented in accordance with the above provisions, and the current lock up period provisions for refinancing shall not apply.

The starting point for the above-mentioned ownership of equity should generally be the date of the industrial and commercial registration change of the specific enterprise it invests in (but if the actual paid in capital is later than the date of industrial and commercial registration, it shall be counted from the actual paid in date). The date of the end of the share issuance shall be the date of obtaining the consideration shares issued by the listed company. Therefore, it is recommended that investment institutions plan the investment period and exit period reasonably, combined with the current review cycle of mergers and acquisitions and restructuring transactions related to the issuance of shares (see Section 7 below for details), and plan the relevant timetable reasonably with the listed company during negotiations.

In addition, if there are related parties of the listed company, such as the controlling shareholder or actual controller of the listed company, among the upper level investors of the investment institution, attention should be paid to whether the investment institution constitutes a related party controlled by the actual controller of the listed company. If so, the lock up period should be consistent with the lock up period applicable to the actual controller of the listed company as the target asset shareholder, which is 36 months; If the investment institution is not controlled by the actual controller of the listed company as the counterparty, it should also carefully judge whether it constitutes a concerted action person of the actual controller of the listed company (as specified in Article 83 of the Measures for the Administration of the Acquisition of Listed Companies). If so, the lock up period may be extended, which may affect the overall post investment exit period of the investment institution. Therefore, it is recommended to carefully consider and, if possible, plan the investment structure when establishing an investment institution.
2. Restrictions on reducing holdings

If an investment institution obtains the consideration for shares issued by a listed company, and the total amount reaches or exceeds 5% of the issued shares of the listed company, in addition to preparing and disclosing a report on changes in equity, it may also constitute a major shareholder of the listed company and be subject to the current "major shareholder" reduction regulations; If the share swap does not reach 5% of the issued shares of the listed company (excluding the original number), according to relevant regulations [4], if the above-mentioned shares are issued after the original "Measures for the Administration of Securities Issuance of Listed Companies" (revised and effective on February 14, 2020), we preliminarily understand that the shares issued for the purchase of assets and supporting financing should not belong to the category of "specific shares". Under the condition of meeting the sales restriction requirements, the exit of investment institutions' projects and the distribution of project profits are generally no different from the current IPO, but still need to be evaluated specifically in conjunction with the trading plan of specific projects.

The regulations regarding the reduction of shares are relatively cumbersome and dynamically limited by specific regulatory policies. In recent years, regulatory agencies have also increased their supervision efforts to impose regulatory measures or penalties on illegal reduction behaviors. We suggest that investment institutions pay full attention to these regulations, fully understand the current rules, and identify relevant operational risks. If you have further questions or inquiries, please contact us for consultation.
3. Performance commitment and compensation

According to the "Measures for the Administration of Restructuring", listed companies are allowed to independently negotiate with their counterparties on whether to adopt performance compensation based on market-oriented principles; If the following conditions are met simultaneously, a performance commitment should be agreed upon, that is, to compensate the listed company for the actual profit of the relevant assets being insufficient compared to the profit forecast:

(1) Pricing method: When using methods such as present value of earnings and hypothetical development based on future income expectations to evaluate or value the assets to be purchased and use them as pricing reference basis;

(2) Transaction object: constitutes a related party merger, that is, a listed company purchases assets from its controlling shareholder, actual controller, or related party controlled by it; The specific diagram is as follows (assuming it does not constitute a restructuring listing):

 

According to the rules, in general, investment institutions do not participate in performance commitments because they are financial investors and do not participate in the operation of the invested enterprise, and cannot lead current and future performance; However, if there are controlling shareholders, actual controllers, or related parties controlled by the listed company of the counterparty among the upper level investors of the investment institution, as mentioned in the "lock up period" section above, it is recommended to carefully consider whether to make performance commitments in advance. If possible, investment structure planning can be done well when the investment institution is established.

Specifically, we have noticed that even if it does not constitute a related party transaction, some M&A and restructuring projects evaluated using the income approach still make performance commitments, and some related party transaction projects also involve external institutions participating in performance commitments limited to their consideration. We understand that the above transaction plan may have been formulated by the counterparty and the listed company in order to facilitate the transaction and obtain regulatory recognition, combined with audit policies and market cases. It may also be required to supplement the betting plan to protect small and medium-sized shareholders due to factors such as high valuation of specific transactions.

Therefore, we believe that investment institutions can combine specific transaction plans and regulatory requirements to comprehensively agree on performance commitments with listed companies. If it is indeed necessary to fulfill performance commitments, then (1) the investment institution may need to fulfill share or cash compensation, and investment returns may be affected; (2) Although the shares held by investment institutions may have reached the lock up period, due to the need to reserve relatively sufficient shares for share compensation, the lock up period may be further deferred until the required specific year's share compensation is completed.
6、 Other relevant points
1. Consider conducting reverse due diligence

In the transaction of issuing shares, investment institutions will become shareholders of the listed company by acquiring shares of the listed company. If the shareholding reaches 5% or more, it may constitute a major shareholder of the listed company, and the overall shareholding period will be longer. For risk control considerations, investment institutions may conduct due diligence on the listed company based on its public information disclosure documents, or with the cooperation of the listed company, conduct due diligence with a certain degree of openness.
2. Shareholder penetration verification and special rights handling

From the perspective of avoiding regulatory arbitrage, we believe that regulatory requirements for shareholder verification and termination of special rights in mergers and acquisitions should be no different from IPO; The former generally focuses on whether private equity fund registration has been completed, whether there are prohibited holding entities under the "Guidelines for the Application of Regulatory Rules on the Disclosure of Shareholder Information of Enterprises Applying for Initial Public Offering", etc. When there are asset management products, contractual private equity investment funds and other entities among the investors penetrated by the upper level of investment institutions, it is also necessary to verify whether they are legally established and effectively existing, whether they are subject to effective supervision by the national financial regulatory authorities, and whether they have led to the issuance of shares to purchase asset transactions involving more than 200 people; If the latter involves the repurchase of the invested enterprise as the obligated party, in principle, the relevant issues of financial liabilities should still be considered, and the termination time of the overall rights should be consistent with the termination time of the IPO project.
3. Condition of the underlying asset

Article 11 of the "Measures for the Administration of Restructuring" stipulates corresponding requirements for the target assets, namely, compliance with national industrial policies and relevant laws and administrative regulations, clear ownership of assets, no legal obstacles to asset transfer or assignment, and legal handling of related creditor's rights and debts.

In addition, in terms of the quality of the underlying assets, the conditions for issuing shares to purchase assets stipulated under the current "Restructuring Management Measures" have been changed to be conducive to enhancing the sustainable operation ability of listed companies, and the previous version of the regulations has deleted the term "sustainable profitability". This latest expression is a comprehensive integration of the legal discourse system of mergers and acquisitions with the current rules for initial public offerings and continuous supervision of listed companies, reflecting the unity of regulatory requirements.

In this regard, we have noticed that investment institutions are very concerned about whether they need to provide defect guarantees for the underlying assets or issues to listed companies, and there are currently relevant cases in the market. We understand that investment institutions can carefully assess the relevant risks based on the attributes of their financial investors and arrange comprehensive negotiations with listed companies in conjunction with transaction plans.
7、 Specific procedures for major asset restructuring

According to the "Restructuring Management Measures", the schematic procedures for major asset restructuring are as follows:

 

In addition to the usual procedures mentioned above, if the listed company is a state-owned holding listed company, it may involve corresponding preliminary procedures such as evaluation and filing, and relevant audits by the State owned Assets Supervision and Administration Commission; In addition, mergers and acquisitions may involve the declaration of concentration of operators and/or foreign investment procedures (if the investor is foreign) due to their merger and other related arrangements. These procedures can be approved in parallel with mergers and acquisitions, but from the perspective of transaction certainty, we recommend completing them before or earlier than the review of the merger and acquisition review committee; For the declaration process of concentration of business operators, it is recommended that investment institutions consider the corresponding legal risks of concentration of business operators at the time of investing in the target enterprise and when placing the listed company; For the foreign investment battle process, we understand that if it does not involve industries restricted by foreign investment, in general, investment institutions holding less than 10% of the shares of listed companies after mergers and acquisitions may not need to go through the foreign strategic investment approval process of the Chinese Ministry of Commerce.

Based on the above legal procedures, according to our observation, non restructuring listed transactions usually take about 4 to 7.5 months from acceptance to obtaining registration approval. If considering front-end procedures such as restructuring plans and drafts, shareholder meetings, etc., the overall time is about 10 to 15 months, depending on the sector and transaction plan.

Therefore, we suggest that investment institutions, in conjunction with relevant legal procedures such as approval and filing, reasonably plan the conditions for the effectiveness of the agreement or the prerequisites for delivery in the transaction documents, as well as possible periods and deadlines.
8、 Preventing insider trading risks

According to recent regulatory cases, insider trading and illegal activities still occur in the field of mergers and acquisitions. According to the "Measures for the Administration of Restructuring" and the "Guidelines for the Supervision of Listed Companies No. 7- Supervision of Abnormal Trading of Stocks Related to Major Asset Restructuring of Listed Companies", the counterparty and its affiliates of major asset restructuring, as well as the directors, supervisors, senior management personnel or main responsible persons of the counterparty and its affiliates, have confidentiality obligations before the disclosure of price sensitive information of major asset restructuring in accordance with the law, and are prohibited from using such information for insider trading. When a listed company is suspected of insider trading or has other abnormal trading situations, the proposed merger and reorganization may be passively terminated due to the risk of insider trading.

In this regard, investment institutions will need to cooperate with listed companies to register insider information, sign confidentiality agreements and transaction process memos (if any), and release information on insider information insider buying and selling of stocks when the formal plan for the proposed merger and reorganization transaction is announced. This includes information on insider information insider and their immediate family buying and selling of the listed company's stocks and other related securities from six months before the announcement of the reorganization application for stock suspension or the first resolution is made (whichever is earlier) until one day before the disclosure of the reorganization report. We suggest that investment institutions and related project personnel strictly restrict stock buying and selling behavior to avoid possible compliance risks.
Appendix: Relevant Laws and Regulations

1. Management Measures for Major Asset Restructuring of Listed Companies

2. Opinions on the Application of Articles 29 and 45 of the Measures for the Administration of Major Asset Restructuring of Listed Companies - Securities and Futures Law Application Opinion No. 15

3. Opinions on the Application of Articles 14 and 44 of the Measures for the Administration of Major Asset Restructuring of Listed Companies - Opinions on the Application of Securities and Futures Law No. 12

4. Standards for the Content and Format of Information Disclosure by Companies that Publicly Issue Securities No. 26- Major Asset Restructuring of Listed Companies

5. Guidelines for the Application of Regulatory Rules - Listing Category No. 1

6. Review Rules for Major Asset Restructuring of Listed Companies on the Shanghai Stock Exchange

7. Review Rules for Major Asset Restructuring of Listed Companies on the Shenzhen Stock Exchange

8. Measures for the Administration of Securities Issuance and Registration of Listed Companies

How are the reduction rules applicable to the issuance of shares for the purchase of assets and the issuance of shares for supporting financing

10. Opinions on Strengthening the Supervision of Listed Companies (Trial)

11. Regulatory Guidelines for Listed Companies No. 7- Supervision of Abnormal Trading of Stocks Related to Major Asset Restructuring of Listed Companies