CHINA: An Introduction to TMT: Equity Financing (PRC Firms)
Venture Capital and Private Equity Investment and Listing in China’s TMT Sector in 2023
In 2023, companies in the TMT sector (“TMT Companies”) in China experienced a slowdown in the investment landscape, particularly in the context of initial public offerings (IPOs) and private equity transactions. Recent data indicates a moderation in overall investment activity and a shift in the composition of investment currency, which both reflect a challenging market environment. Despite this general slowdown, certain industries within the sector remained active, notably the semiconductor and artificial intelligence technology (AI) industries, which emerged as prominent areas of interest for investors and companies alike.
First, in terms of IPOs, 59 Chinese TMT Companies successfully debuted in the A-share market in 2023, according to sources. Notably, the semiconductor industry stood out by leading fundraising efforts and occupying the top three positions in the amount raised through A-share market in 2023. This achievement underscores the resilience of the industry despite broader economic uncertainty.
Second, Chinese TMT Companies continued to seek listings in international markets. Four Chinese TMT Companies listed on the Nasdaq in 2023, including Global Mofy (GMM), Intchains (ICG) and MultiMetaverse (MMV). Also, 12 Chinese TMT Companies listed in 2023 on the Hong Kong Stock Exchange: RoboSense (02498), Ubtech Robotics (09880), BaTeLab (02149), iMotion (01274), Maiyue (02501), ZX Inc. (09890), Fourth Paradigm (06682), Be Friends (01450), Edianyun (02416), Powerwin Tech (02405), Gala Technology (02458), and WellCell (02477).
Turning to private equity investment within the TMT sector, there was a slowdown in overall activity in 2023. Specifically, capital inflows were clearly concentrated in the fields of AI and semiconductors, and investors preferred long-standing TMT Companies.
Delving deeper into specific industries, the semiconductor industry accounted for the majority of TMT investment and financing activities in 2023, contributing around 20%–25% of investments within the TMT sector. There were over 600 investment and financing transactions in the semiconductor industry in 2023, totalling approximately RMB150 billion, with a significant majority completed in RMB. Simultaneously, the AI industry also saw nearly 600 investment and financing transactions, amounting to about RMB73 billion. In addition, other industries such as big data, media, entertainment, and digital services also experienced investment and financing activity, albeit to a lesser extent.
Geographically, investment activities were particularly concentrated in key regions such as Guangdong, the Yangtze River Delta, and Beijing. Furthermore, there has been a shift in the composition of currency used for investments, with a sharp decline in investments made in US dollars and a corresponding rise in transactions denominated in RMB.
In conclusion, the TMT sector in China experienced a widespread slowdown in investment activity in 2023, which is reflected in a reduced number of investment and financing activities across various industries. Additionally, there has been a decrease in the total amount invested in these industries, indicating a challenging environment for TMT Companies and investors alike. While certain segments, such as AI and semiconductor, continue to attract investments, the overall industry is navigating serious challenges which require strategic adaptation and resilience to achieve sustained development.
New rules for overseas securities offerings and listings
Chinese TMT Companies have long shown a preference for public listings outside of mainland China, mainly due to stringent requirements imposed on listing applications in the A-share capital market. Because of regulatory issues, overseas listings are typically structured through offshore holding companies, which are most commonly registered in the Cayman Islands or the British Virgin Islands. These holding companies, in turn, control their Chinese operating companies by equity or contracts (known as red-chip structures). Furthermore, as many TMT Companies face foreign investment restrictions, they employ variable interest entity (VIE) structures.
On 17 February 2023, the China Securities Regulatory Commission (CSRC) issued the Trial Measures on the Administration of Overseas Securities Offerings and Listings by Domestic Enterprises and five supporting guidelines (the “Overseas Listing Rules”), which took effect on 31 March 2023. These Overseas Listing Rules signify a shift toward a unified filing system for overseas offerings and listings by China-based companies.
Before the adoption of the Overseas Listing Rules, CSRC approval was required for a PRC domestic company to issue shares outside China (for example, in connection with the listing of H-shares) or for a red-chip company to issue shares if its ultimate controller was a PRC entity (eg, state-owned enterprises), but not where the ultimate controllers were PRC individuals.
Now, under the Overseas Listing Rules, all China-based companies (including red-chip companies with or without VIE structures) must make record-filings with the CSRC in connection with their overseas securities offerings and listings. Although the required procedure is called “record-filing”, for an IPO in an overseas jurisdiction, it is essentially a regulatory review process, although it is less extensive than a formal review for a domestic listing. The review process can take several months, during which the prospective issuer responds to comments from the CSRC.
By the end of 2023, approximately 160 enterprises had filed for overseas listings under these rules and about 70 had successfully completed process. It appears that the CSRC filing process is gradually evolving into a more routine supervisory procedure, fostering predictability for all market participants.
However, the review timeline is particularly uncertain if VIE structures are involved, as the CSRC needs to consult with the relevant industry regulators before it renders its decision. Among the enterprises that have successfully completed the filing process, only two enterprises had VIE structures. This presents a challenge for many TMT companies which have adopted VIE structures to seek overseas offerings and listings.
Newly revised Company Law
At the end of 2023, news broke that the national legislature adopted revisions to the PRC Company Law (the “2024 Company Law”), which will enter into force on 1 July 2024 and is regarded as a fundamental law for the VC/PE industry. The numerous revisions in the 2024 Company Law take into account prevailing market practices in the VC/PE industry (for example, recognising different classes of shares in a privately held joint-stock company), and also incorporate more comprehensive protections for shareholders and creditors. We believe that the 2024 Company Law will bring about positive changes in China’s equity financing practices. Below, we discuss three topics we find to be particularly salient for the VC/PE industry regarding the 2024 Company Law.
First, the 2024 Company Law will require all shareholders of a limited liability company to fully contribute their subscribed registered capital within five years of the company’s establishment. The current capital payment system in China allows for flexibility in setting the payment schedule, which can extend throughout the company’s existence. In practice, many companies set registered capital amounts that exceed the company’s actual capital needs and contribution schedules that extend for long periods. With adoption of the 2024 Company Law, it is now imperative for limited liability company shareholders, including founders of startups, to re-evaluate their subscribed registered capital amounts and consider whether it is prudent to amend the company’s registered capital and contribution schedule.
Second, all joint-stock companies will be permitted to issue different classes or series of shares which bear preferential or subordinate property rights and/or special voting rights, or are subject to transfer restrictions. Under current law, this is permitted only for listed companies and unlisted public companies. We view this revision as favourable for the VC/PE industry, as it is in line with actual capital structures in the industry.
Third, the 2024 Company Law provides that capital reductions are generally permitted on a pro rata basis with a two-thirds voting majority, and non-pro rata capital reductions (ie, targeted reductions) are permitted by unanimous consent of the shareholders of a limited liability company or contrary provisions in a joint-stock company’s articles of association. Ambiguity has existed as to whether targeted capital reductions require unanimous consent of all shareholders of a company. While current law provides that capital reductions require a two-thirds voting majority for approval, some people’s courts and administrative authorities required unanimous approval or shareholder consent. This revision clarifies the legal requirements for capital reductions and grants greater flexibility to shareholders and investors.
Summary
The Overseas Listing Rules and 2024 Company Law introduce significant changes to the legislation and investment environment for equity financing and overseas offering and listing for TMT Companies. As we navigate this evolving legal landscape, we will continue to monitor the practices of the new rules in this area. Our hope is to witness a resurgence in equity financing and the overseas offering and listing transactions of China-based TMT Companies in 2024.