How to Conduct Thorough Country-Specific Due Diligence and Solve Problems in Overseas Equity Transactions? | Overseas Expansion Practical Training Ca

As Chinese enterprises go global and face more complex challenges, the importance of legal compliance has become increasingly prominent. How can enterprises conduct accurate and effective preliminary due diligence on different overseas destinations? How can enterprises design an equity structure that is tax - friendly and "flexible for both expansion and contraction" to reduce the cost of overseas trade? How can enterprises avoid legal compliance risks during the process of going global, coordinate the core terms of transaction documents and advance the transaction steps?

On May 16th, the second phase of the "Overseas Expansion Practical Training Camp" jointly organized by the International Service Center for Chinese Enterprises and Fangda Partners launched a special session on legal compliance. Focusing on the practical operations of enterprises going global and specific case studies, it decoded how overseas - going enterprises can properly handle overseas equity investments and effectively avoid legal compliance risks in the new global landscape.

01 Comparison of the Advantages of Overseas Equity Structures

From the preparation of the letter of intent and legal due diligence before going global, to the drafting and negotiation of documents in the early stage of equity transactions, and then to the transaction closing process and post - investment management, legal compliance work covers every aspect of an enterprise's cross - border investment.

Lawyer Xue Feng particularly mentioned that judging the feasibility of a project before cross - border investment is crucial for avoiding major mistakes in the later stage, ensuring the smooth completion of the transaction, and the stable operation of the investment project. In the initial design stage of the letter of intent and transaction structure, enterprises need to conduct research on the legal environment, industry access, transaction system architecture, and intended services of the host country, analyze the feasibility of overseas investment at the minimum cost, or make corresponding adjustments to the plan.

Specifically regarding the cross - border equity structures available to enterprises, Lawyer Xue Feng introduced four common overseas equity structures, as well as their respective advantages and disadvantages:

1 Direct Establishment of Overseas Subsidiaries

That is, through the ODI (Overseas Direct Investment) approval, directly establish overseas subsidiaries. According to the company's tax planning needs and industry sensitivity, an overseas intermediate company can be considered to be set up to reduce the tax burden or, to a certain extent, reduce geopolitical risks.

Although this model has advantages such as relatively simple structure establishment, low communication cost with existing shareholders, being conducive to attracting RMB investment and domestic listing in the future, and relatively low group management cost, the trouble lies in that the capital link involves cross - border transactions. The foreign exchange management department needs to consider the enterprise's overseas investment quota, the destination of the investment, and the enterprise's business. Moreover, the capital flow can be traced back to the parent company, exposing the highest risk. In this regard, the overseas subsidiary can act as a minority shareholder to conduct a joint - venture transaction with a local enterprise, thus avoiding exposing the parent company in the equity structure.

2 Red - Chip Structure

Reorganize the existing pure domestic structure of a Chinese company into a group company with a Cayman or overseas holding company as the parent company, holding the Chinese operating entity and other overseas operating entities through a series of overseas structures.

Compared with the direct shareholding model, the advantages of red - chip restructuring are: it is easier to attract US - dollar investors and is conducive to listing on overseas stock markets. Under a suitable structural arrangement, it is relatively less affected by geopolitical risks.

However, it also has the following disadvantages. For example, the time and capital costs of restructuring may be relatively high, and the company needs sufficient cash flow for capital circulation. If the company has had several rounds of domestic financing, the communication cost with existing shareholders during red - chip restructuring is relatively high, and there may be situations where existing shareholders do not have overseas holding entities or cannot be rolled up to overseas holding.

Therefore, this model is suitable for companies that naturally attract US - dollar investors or have a capitalization path in overseas capital markets. They can choose whether to go global through red - chip restructuring according to the situation of existing shareholders and funds.

3 Parallel Structure

This is a dual - cycle structure both at home and abroad. That is, the original shareholding structure of the domestic company remains unchanged, and a separate structure is established overseas specifically for overseas financing and overseas business cooperation, with no equity connection between the two.

This equity structure model is suitable for enterprises that do not seek listing because listing will cause issues such as related - party transactions and industry competition. The advantage is that it separates domestic and overseas companies, playing an isolation role, and the overseas company is almost 100% foreign - funded. However, the problem of the difficult coordination of the rights and interests of domestic and overseas investors needs to be considered, and the capitalization path needs to be carefully planned.

4 NewCo Model

The NewCo model means that an enterprise uses its core technology to cooperate with an overseas company, obtains licensing fees and technology royalties to supplement part of its cash flow, and at the same time retains a certain amount of equity. If the enterprise goes public, it can obtain a share premium as a minority shareholder, equivalent to getting two sources of income.

However, the disadvantage is that transferring important technology to other companies will reduce the economic value of the company's valuation and is also not conducive to the valuation of split pipelines. Issues such as the coordination of the interests of the original domestic investors, the distribution of the rights and interests of domestic and overseas investors in the overseas company, and the operation and exit of the overseas company need to be concerned. The NewCo model is currently mainly used in biopharmaceutical companies involving pipeline licensing.

02 Merger and Acquisition Transactions

There are mainly three common overseas expansion paths for enterprises: export and cooperation with suppliers, investment and self - construction (greenfield investment), and overseas shareholding or control. For overseas shareholding or control, enterprises often involve different types of equity transactions, mainly including:

1 Vanilla M&A: The most traditional M&A method, obtaining greater control by acquiring the equity of an overseas enterprise, integrating profits into the company's financial statements, and achieving profit growth through the merger of operating entities.

2 Pre - IPO / VC: Conduct valuation and minority equity investment in early - to - mid - stage enterprises, and exit through valuation increase, trade sale / IPO.

3 Buy - out: Control the entire business and conduct in - depth integration, and make profits through better operation than existing shareholders / management.

4 Joint Venture: A joint - venture transaction where both parties invest their respective resources. For example, Enterprise A provides funds and Enterprise B provides management technology for cooperation.

5 Strategic: Strategic investment, which can not only obtain value - added through minority equity investment but also achieve the goal through strategic cooperation requirements, belonging to "having both advantages".

Among them, M&A - type transactions refer to directly acquiring overseas company targets. For large - scale groups, the complexity lies in the integration of the business and organizational structure of the acquired company.

M&A - type transactions include the following steps:

1 Preparation Stage

During the initial contact process, judge whether the target is suitable with limited energy and resources. Both parties need to clarify the intention to buy and sell and the approximate price range and other pre - conditions for the transaction.

At this stage, both parties will sign a term sheet. The term sheet is non - binding, aiming to set business expectations for both parties. It will stipulate some terms, including the exclusivity period (no - shop), which provides protection for the buyer / investor, giving them a definite window period to conduct due diligence on the company; stipulating that in the case of the seller or the company's fault, the buyer's transaction costs will be borne; and the non - poaching commitment, ensuring that the buyer can safely contact the company's employees or customers.

2 Due Diligence Stage

It includes investigating the investment environment of the host country, such as restrictions on foreign investment access, restrictions on foreign shareholding ratios, foreign exchange control, etc. When establishing and governing a company, consider the local company's organizational form, establishment procedures, mandatory requirements for corporate governance, restrictions on equity transfer and dividends, etc.

Lawyer Xue Feng particularly mentioned that when an enterprise writes transaction documents and involves international arbitration clauses, it should pay attention to whether different countries recognize each other in the implementation process of international arbitration.

In addition to country - specific due diligence, other important issues in an enterprise's legal due diligence also include:

Buying the right things at the right price.

Does the target company fully own the business assets?

Are there any other unknown / contingent debt risks?

Are there any major risks or defects in the following aspects of business operations?

The discovered due - diligence issues can be classified into the following 4 categories:

Non - material issues: Only need to be reported, but no action is required.

Due - diligence issues that need to be addressed in the documents: Handle them as pre - closing / post - closing matters; hedge the loss risk through compensation clauses; hedge the unknown risk through representation and warranty clauses.

Matters that can be adjusted through price: Cash / debt / working capital; cooperate with other deferred payment or escrow account mechanisms.

Major issues that may lead to the breakdown of the transaction: Issues that shake the fundamental business logic of the transaction.

3 Document Stage

Transaction documents are mainly divided into two types: One is the SPA (Share Purchase Agreement), which will clarify the terms of the target assets / equity transfer, including the purchase price, closing conditions, guarantee and compensation mechanisms. The other is the SHA (Shareholders' Agreement), which is applicable when the buyer is a minority shareholder. The buyer needs to protect their rights and interests through the SHA to prevent equity dilution. Minority shareholders have the preferential liquidation right to ensure the priority recovery of investment when exiting; when the major shareholder sells equity, minority shareholders can require joint - sale; and there are also anti - dilution rights to prevent the dilution of equity value caused by subsequent financing.

4 Post - signing and Post - closing Stages

Enterprises need to pay attention to factors that may affect the transaction schedule. For example, if the target assets involve sensitive industries (such as energy and chemicals), the risk of national security review needs to be evaluated in advance; for cross - border transactions, attention should be paid to the compliance of capital going overseas (such as ODI approval). In terms of employee and supply - chain risks, layoffs after the merger may trigger labor disputes, and compensation funds need to be reserved; the change - of - control clause may trigger the termination of supplier / customer contracts.

03 Joint - Venture Transactions

Compared with SHA - type M&A, although joint - venture transactions also involve both parties investing in a company, they pay more attention to the balance in equity distribution, such as 51% vs. 49% (unilateral control) or 50% vs. 50% (a deadlock mechanism needs to be preset). Secondly, the two parties to the joint venture should provide differentiated resources (such as one party providing funds and the other party providing technology / land) to reduce competition and conflicts. If the businesses of the two investing parties overlap (such as both being technology providers), it is easy to cause disputes due to profit distribution.

In addition to geopolitical sensitivity, problems that a joint - venture company may encounter include corporate deadlock, which can be resolved by setting up a drag - along right (one party can force the sale of all the company's equity) or a repurchase right (one party can require the other party to repurchase the equity at an agreed price). For the need for consolidation (shareholding ≥ 50%), the enterprise needs to ensure that the governance structure of the joint - venture company supports control rights (such as having more than half of the board seats); if it is a financial investment (shareholding ≤ 20%), then the SHA needs to be used to safeguard the dividend right and the exit path.

Invited Guest

Xue Feng

The keynote speaker, Xue Feng, is a partner in the Shanghai office of Fangda Partners. His main business areas include mergers and acquisitions, private equity investment and financing, joint - venture transactions, cross - border restructuring, and foreign investment. Lawyer Xue is good at designing suitable transaction plans and structures according to the commercial needs of industrial clients. Some of the acquisition transactions he has handled in the past have also won annual transaction awards from international professional legal rating agencies.

Fangda Partners was established in 1993. It is an integrated comprehensive law firm providing legal services in Chinese law and the laws of the Hong Kong Special Administrative Region of China. It also has offices in Beijing, Guangzhou, Hong Kong, Nanjing, Shanghai, Shenzhen, and Singapore. Currently, it has about 800 lawyers in total, providing legal services for large multinational companies, global financial institutions, many leading Chinese enterprises, and fast - growing technology companies. It has rich practical experience and professional resources in going global and is good at providing more targeted, high - quality, and cost - effective overseas legal services.

This article is from the WeChat official account "Hangzhou Qiantang Enterprise Overseas Expansion Service Base". The author is Qiantang Going Global. It is published with authorization from Qiantang.