Key Pathways for Chinese Companies to Go Public in the U.S.

[Michael's Chinese Law Series-Compliance & Dispute Resolution]

The U.S. capital market, known for its influence, depth, and transparency, offers a variety of listing options for Chinese companies seeking to raise capital. The U.S. market is characterized by its robust liquidity and diverse securities market layers, catering to the financing needs of companies of all sizes and growth stages. The success of a Chinese company's listing in the U.S. hinges on its fundamentals and investor recognition.

1. Initial Public Offerings (IPOs) - Red Chip & VIE

IPOs are the traditional route for companies to go public. There are two main underwriting methods: "Firm Commitment," where underwriters purchase the securities and then resell them to investors, and "Best Efforts," where underwriters only sell the securities they can and return the unsold portion to the issuer. Chinese companies often establish offshore entities in tax havens like the Cayman Islands or the British Virgin Islands to facilitate their U.S. IPOs, leveraging tax benefits and circumventing regulatory hurdles.

1. 1.1 Red Chip Structure: This involves Chinese mainland companies setting up offshore companies, typically in tax havens like the Cayman Islands or British Virgin Islands, and then transferring assets to these offshore entities for listing abroad.
2. 1.2 Variable Interest Entity (VIE) Structure: A special form of the Red Chip model, VIE allows for the indirect listing of domestic interests by using a series of contracts to control the domestic company's equity, bypassing direct ownership or acquisition.
3. The VIE structure offers several key advantages, particularly for Chinese companies looking to list overseas:
4. 1) Tax Benefits: The VIE structure adeptly navigates around the current restrictions on the free convertibility of the Chinese currency. By establishing offshore entities in jurisdictions such as the British Virgin Islands or the Cayman Islands, companies can benefit from substantial tax exemptions and lower costs associated with equity transfers. Additionally, these entities can pursue listings in Hong Kong or other jurisdictions, broadening their capital-raising opportunities.
5. 2) Regulatory Evasion: The VIE model effectively circumvents domestic legal and regulatory constraints, including oversight on foreign investment. By packaging domestic assets under an offshore entity, Chinese companies can list their assets overseas, thus avoiding restrictions imposed by Chinese regulatory bodies on foreign investment in certain industries. This strategy also facilitates successful capital raising on the U.S. capital markets.
6. 3) Advantages of Establishing a Hong Kong Company: Within the VIE structure, having a Cayman Islands company establish a wholly foreign-owned enterprise (WFOE) in Hong Kong is advantageous due to the special tax arrangements between mainland China and Hong Kong. Under the Enterprise Income Tax Law effective from January 1, 2008, foreign enterprises without a physical presence in China are subject to a 10% withholding tax on dividend income, unless a tax treaty provides otherwise. However, due to the avoidance of double taxation agreement between mainland China and Hong Kong, dividends derived from mainland China by Hong Kong companies that meet the stipulated conditions can be taxed at a reduced rate of 5%. This tax arrangement has made Hong Kong an attractive location for holding companies within the Red Chip structure, allowing them to enjoy preferential withholding tax rates on dividends from mainland China.

2. Reverse Merger (Backdoor Listing)

Reverse mergers, or backdoor listings, involve acquiring a publicly-traded shell company in the U.S. and then merging it with the Chinese company. This method is quicker and less expensive than an IPO but carries significant risks, including potential SEC investigations due to issues like financial misrepresentation.

3. SPAC (Special Purpose Acquisition Company) Mergers

SPAC (Special Purpose Acquisition Company), also known as a blank-check company, is unique in that it is established with the sole purpose of raising capital through an IPO to acquire an existing company. This process is often referred to as a "cash shell" or "cash IPO," as SPACs begin with no assets other than cash raised from the IPO. The SPAC then identifies and acquires a target company, injecting it with high-quality assets to potentially increase its stock value.

SPACs are subject to regulatory constraints, including: (1) The requirement to place over 90% of the IPO proceeds into a third-party escrow account (unless the company has completed an acquisition transaction worth at least 80% of the funds raised) and (2) If the SPAC fails to complete an acquisition within 24 months of its initial registration statement, the IPO proceeds must be returned to investors, effectively marking the SPAC as unsuccessful. These rules imply that if a SPAC successfully completes an acquisition within two years, investors may see their SPAC shares appreciate based on the performance of the acquired assets. If the SPAC fails, investors essentially receive a return on their investment, akin to a fixed interest rate on a time deposit.

In terms of corporate equity structure, there is no difference between a SPAC's listing on the U.S. stock market and other companies. Chinese companies must decide whether to adopt a traditional equity control structure or establish a VIEstructure, depending on their specific circumstances.

The SPAC model offers several advantages: it allows for listing without a clear business plan, there are no restrictions on who can invest in a SPAC, and the SPAC IPO occurs before the acquisition, allowing for a potentially quicker path to market. The exit strategy for SPACs is straightforward, involving the sale of shares. However, a downside of the SPAC model is that the final transaction price is negotiated between the SPAC and the target company, which could result in the acquired company's shares being sold at a price lower than what might be achieved through an IPO.

4. Direct Listings

Direct listings allow companies to list their shares on an exchange without issuing new shares or raising capital. This method bypasses the traditional IPO process and associated underwriting fees, but it lacks the liquidity provided by underwriters and may result in higher stock volatility.

5. American Depository Receipts (ADRs)

ADRs are certificates issued by U.S. banks representing shares of non-U.S. companies. ADRs enable foreign companies to trade their shares on U.S. exchanges, making them more accessible to U.S. investors.

6. Private Placements and Rule 144A

Private placements allow companies to raise capital without registering with the SEC, targeting qualified institutional buyers. Rule 144A provides a framework for selling securities to these institutions without the need for SEC registration.

(Michael Chen, JunHe LLP Shanghai)