According to the data included in the World Investment Report 2017 and the 2016 Statistical Bulletin of China's Outward Foreign Direct Investment, the amounts of outbound direct investment (ODI) and foreign direct investment (FDI) have amounted to 196.15 billion US dollars and 133.7 billion US dollars respectively, since 2016.
In 2015, China’s ODI amount first exceeded its FDI amount, while in 2016, the gap between ODI and FDI became even bigger, while China realized a net capital output under two-way direct investment for two consecutive years. In the context of Chinese enterprises increasing their outbound investment year after year, the ways in which Chinese enterprises can be assisted in constructing outbound investment frameworks become especially important. Enterprises select different frameworks in their overseas merger and acquisition projects. A great number of factors have to be considered in such a selection. This article mainly describes how to assist Chinese enterprises in selecting and constructing the structure of transaction most suitable for their overseas mergers and acquisitions.
According to the assets purchased by Chinese enterprises in overseas merger and acquisition projects, the overseas deals could be classified into stock acquisitions and asset acquisitions deals. Stock acquisition refers to the acquisition of part or all of the stocks of the target enterprise in a direct or indirect way by the acquirer, or the subscription of new stocks issued by the target enterprise. Asset acquisition refers to acquiring part or all of the target enterprise’s assets by the acquirer. The main differences between these two models of acquisition are as follows
As the stock acquisitions and asset acquisitions involve different targets, the items and sum of taxes herein in such two ways could be different. As for overseas mergers and acquisitions, Chinese enterprises need to compare the tax burdens of the two models in order to choose the one with the lower tax burden.
During stock acquisitions, the acquiring enterprise will eventually become the shareholder of the target enterprise, while the target enterprise should generally assume all previous debts and liabilities. This leads to significant contingent liability risks on the part of acquiring enterprises.
During asset acquisition, comprehensive due diligence will lead to a fairly clear understanding of the assets of the target enterprise. To control the risks related to any proposed acquisition, the acquiring enterprise merely needs to focus on the inherent claims and debts concerned with the assets.
Therefore, Chinese enterprises, which are involved in overseas mergers and acquisitions, need to take into overall consideration of the composition and structure of the target enterprise’s assets so as to choose stock acquisition or asset acquisition model as the appropriate transaction mode. If a Chinese enterprise eventually chooses to acquire and merge with a foreign enterprise through the stock acquisition model, it may be confronted with contingent liability risks. Generally speaking, the aforesaid contingent liability risks existing in the stock acquisition model can be prevented and controlled using the following methods:
Preliminary due diligence is an important foundation on which all parties concerned should design the structure of transactions and facilitate the signing of transaction documents. Detailed and prudent investigation needs to be implemented at the due diligence stage to discover possible or potential debt issues of target enterprise.
The acquiring enterprise can set proper warranty clauses or termination clauses in transaction documents to mitigate risks. If any risk which is not discovered in the preliminary due diligence stage emerges during the process of acquisition, the acquiring enterprise can terminate the transaction timely.
In common practice, the acquiring enterprise may define the payment progress in the transaction document and divide the payment progress in accordance with specific milestones.
After a Chinese enterprise decides to adopt the stock acquisition model or the asset acquisition model for overseas acquisitions, it shall further construct different frameworks for acquisition, i.e. direct acquisition or indirect acquisition, according to specific circumstances.
(I) Direct acquisition, i.e. direct acquisition of overseas enterprises or projects by domestic entities
The specific structure is shown in the figure below:
To adopt the direct acquisition framework, the following factors should be taken into consideration :
In contrast with indirect acquisition, direct acquisition doesn’t require the acquiring enterprise to set up a special purpose vehicle (SPV). Instead, the acquiring enterprise will directly acquire the overseas enterprise’s stocks or assets, in which the structure is quite simple and clear.
With the current trend of increasingly strict supervision, as the acquiring party has no need to establish any SPVs in direct acquisition model, the ownership structure or deal structure can be easily defined without penetrating SPVs, then such model is encouraged by authorities such as the State Administration of Foreign Exchange.
(II) Indirect acquisition, i.e. a domestic entity sets up one or multiple levels of entities for acquisition. The specific structure is shown in the figure below:
To adopt the indirect acquisition framework, the following factors should be taken into consideration:
One important factor for domestic enterprises to set up SPVs to indirectly acquire overseas target enterprises is to lower the tax burden.
Through setting up an overseas SPV, a domestic enterprise can obtain overseas market finance which could facilitate cross-border capital flows and provide sufficient funds for mergers and acquisitions.
A multi-tiered acquisition structure also makes it convenient for the acquiring enterprise to sell assets and conduct reorganization in the future.
Regardless of which acquisition model or framework an enterprise chooses, they have to obtain approvals from relevant authorities such as the Ministry of Commerce and the National Development and Reform Commission (NDRC). As for domestic enterprises’ overseas investment, the main approval and record-filing procedures with the NDRC and relevant commercial departments are as follows.
After a Chinese enterprise locks certain assets overseas, firstly, it shall choose either the stock acquisition or asset acquisition model according to the specific conditions. Then, after taking into consideration the financing requirements, the procedures of supervision and approvals, as well as the transaction costs, it shall adopt an overseas merger and acquisition model based on its own situation, set up a reasonable structure for overseas acquisition, and eventually complete the transaction in a reasonable and effective way.
P17, Ministry of Commerce Report On Development of China's Outward Investment and Economic Cooperation 2017, link: http://fec.mofcom.gov.cn/article/tzhzcj/tzhz/upload/zgdwtzhzfzbg2017.pdf
