中文|EN
Home >Publications
The Basic Structure Of “Reverse Takeover”
2008/10/01 | 分享文章

Author: Xu Meng  Wen Chengwei

 

"Reverse takeover" (RTO) has always been an important way for enterprises to go public. Following a series of changes in market conditions, RTO has attracted more attention from enterprises under the "bear market" condition. This article is intended to briefly analyze the basic concept of the RTO and the key issues that enterprises intending to go public must consider.
 

"Reverse takeover" (RTO) has always been an important way for enterprises to go public. Following a series of changes in market conditions, RTO has attracted more attention from enterprises under the "bear market" condition. This article is intended to briefly analyze the basic concept of the RTO and the key issues that enterprises intending to go public must consider.
  
For the past six months and more, with the weakness in the secondary market, the examination and approval procedures for IPO (initial public offering) by regulatory authorities have been significantly slowed down. For many enterprises wishing to go public, the IPO seems to be a dream that will never come true in a short time. At the same time, the cost of taking over listed companies appears to have declined markedly due to the drop of stock prices. The above two factors have made the RTO popular again. Then, how do enterprises buy shells?

 

Ⅰ Basic Concept of RTO
 
 

 The "Value theory" is a theoretical principle in economics that only a thing of value can be accepted by and circulated among people. As a legal subject, a listed company itself has two kinds of values: 1. The value of a shell, e.g. the qualifications of finance in the securities market; 2. The value of operation, e.g. the company’s brands, products, assets and profitability. The “shell” as mentioned in this article refers to those listed companies which are not operating properly and only have the value of a shell while basically do not have the value of operation. 

 

The so-called RTO usually refers to that a non-listed company becomes a controlling shareholder of a listed company through the acquisition of the shares of the listed company, and invests its own assets in the listed company, finally realizing a successful listing of its own assets. From literal meaning, it can be seen that “buying a shell” is closely related to “going public”. A company won’t go public if it does not buy a shell, or it will be unimportant to buy a shell if the company does not plan to go public.

 

Compared to debt financing, financing through securities market is relatively with low cost but in large scale, therefore, even if a listed company is not operating properly, its "shell" is still valuable and has become relatively scarce resources coupled with the limited number of listed companies, winning the favour of those non-listed companies which have a strong need of financing. 

 

Ⅱ Main Steps in RTO

 

In general, the RTO is divided into three steps:

 

The first step is to buy a shell, that is, a non-listed company becomes a controlling shareholder of a listed company through the acquisition of the shares of the listed company. In terms of the mode of acquisition, the “Administrative Measures on the Acquisition of Listed Companies” have provided three modes: acquisition by offer, acquisition by agreement and indirect acquisition. 

 

The second step is the replacement of asset or asset contribution. To improve the situation of poor management of a listed company, the most convenient way is nothing more than replacing or inputting new “blood”, that is, to replace old assets with new ones or contribute new asset to the listed company. 
 
The third step is that the company increases its issuance of stocks to achieve the purpose of financing.

 

Please see the specific process as shown below:

 
 

Description:
1. The "shell seller" transfers its equity to the “shell purchaser” who makes the payment to the “shell seller”.
2. The “shell purchaser” replaces the current assets of the listed company with its own good assets or invests new assets in the listed company;
3. The “shell purchaser” increases the issuance of stocks to achieve the ultimate purpose of RTO—financing. 

 

Ⅲ Issues To Be Noticed in Selecting A Shell

 

(A) Whether the government is supportive

 

As it is earlier mentioned, the "shell companies" in the market are mostly listed companies which are operated poorly. Because of poor management, these enterprises often have serious problems in the aspects of debt, taxation, employee settlement and so on. If these problems cannot be solved, the cost of corporate restructuring will be increased thus affecting the efficiency of corporate restructuring. Therefore, whether the acquisition of shells can be completed successfully depends not only on the acquisitions price and plan, but also largely on the support of the local government, banks and other departments and institutions.

 

(B) Better to select a local "shell"

 

From the government’s point of view, the restructuring of a “shell” company by a company with good business performance would have a very important effect in social stability, promoting local economic development and protecting the interests of small and medium shareholders, so as long as the acquisition plan and price are reasonable and the communication is adequate, it will usually be supported and understood by the government. However, another factor should not be neglected that local governments, in most cases, are reluctant to allow a listed company to relocate in other places due to restructuring. In other words, local government and banks will not support any company to purchase a shell in return of nothing or for anyone else’s sake. A win-win solution is to acquire a local “shell” for public listing, so that the number of local listed companies will not be reduced while improving the quality of assets of these listed companies.

 

(C) To select a "clean shell"

 

The so-called "cleanness" refers to that there is no unforeseen debt or other risk existing in the shell company. In practice, the "cleanness" is a relative concept since existing enterprises are always in the state of business operation, no one can, at any time, ensure that the shell company has verified and handled all the debts and risks. Therefore, the standard of the so-called "clean shell" should be reasonably determined. It is generally believed that a shell is clean if it has a clear equity structure and properly arranged its significant and major debts, or has less debts and the information is fully disclosed. From the perspective of regulatory agencies, the acquisition of a "clean shell" will generally not leave many substantive issues to the listed company, which helps protect the interests of small and medium investors.

 

(D) The timing of buying a "shell" should be noticed

 

The acquisition of a shell is a transaction in nature and the success of any transaction lies in no more than two aspects: a reasonable price and mutual consent. As to the timing of buying a shell, buyers may buy the shell: when its stock price is relatively low; or when the shareholders of the shell company are willing to sell it. Otherwise, either the cost of transaction will be highly increased due to the exorbitant prices made by the seller, or the transaction will be long delayed if the seller (or even relevant local government) is not determined to sell the shell.

 

In my view, there has a great similarity between the transaction of shells and that of stocks. For buyers, it is easy to buy a shell in the “bear market”, while for sellers, it is easy for them to sell a shell in the “bull market”. As to the best timing of transaction, it depends on the judgment on market direction by the buyers and sellers. 

 

(A) Tax issues

 

The restructuring of a listed company by a “shell buyer” can be divided into the transfer of assets and the acquisition of assets. Since the assets involved in the restructuring of the listed company are relatively large, so the restructuring cost will be increased if the taxes are too high. Therefore, the “shell buyer” should, in addition to making efforts to obtain government support to reducing or eliminating local taxes, take full account of the tax arrangement in the program design.

 

The “Notice on Several Corporate Income Tax Issues Concerning Corporate Equity Investment” (Guoshuifa [2000] No.118) issued by the State Administration of Taxation has provided convincing references for us in the program design. The provisions in Article 5 of the Notice were fully applied: “In an overall asset replacement transaction, if the monetary assets as a supplementary consideration of the assets replacement transaction take no more than 25% of the fair value of the total input assets, upon approval and verification by the tax authority, neither of the two enterprises replacing assets shall confirm the income or loss of the transfer of assets”, which greatly reduced the restructuring cost. 

 

(B) The change of qualifications of "shell" companies

 

Since many industries such as the pharmaceutical industry, food industry, financial sector and mining industry apply the approved licensing system under China's current system, so enterprises may start business operation only after they have obtained relevant approval document and license certificate. Although these industrial license and qualification are granted to the legal principle (i.e. the “shell” itself) based on the nature of the enterprises’ property, when the asset is transferred out of the “shell” company, relevant qualification is unnecessary for the “shell” company but is a must for the asset being transferred out of the company. Since the legal principal qualification of the “shell” company still exists, there still exist legal obstacles for transferring relevant qualifications together with the asset. 

 

If the replacement of assets involves only equity, the above issue should be easy to solve, but if it involves other types of assets, the relevant transfer of qualifications or the change of principal should be solved by relevant departments with the government’s coordination. 

 

(C) The handling of consideration difference

 

During the process of asset restructuring, the asset inputted in the “shell” company should be better than the existing assets of the company and the scale of the inputted asset is often larger than the existing asset. The difference part of the asset is usually handled in the following ways:

 

1. If the difference is smaller, this part can be regarded as a debt of the “shell” company to the “shell purchaser” in a contract and the repayment schedule should be worked out.
2. If the difference is larger, the “shell” company will usually issue a certain number of stocks to the “shell purchaser” to purchase the differenced asset.

 

(D) The handling of claims and debts of the company

 

The handling of claims and debts is what we called "to clean a shell", which is key to a successful acquisition of a "shell", because no buyer wants to buy a "shell" with lots of debts or under guarantees and the regulatory institutions are also cautious about the restructuring of a “unclean shell”. As mentioned above, "cleanness" is only a relative concept and has not been defined in any legal document. The regulatory institutions currently take the following criteria: contingent debts should be entirely transferred, financial debts should be paid off and 80%-90% of other debts should be repaid. If the above requirements cannot be fulfilled, the acquisition of a “shell” often ends up with failure. 
 
In order to encourage properly-operated enterprises to go public, local governments have formulated the listing rules for local enterprises and fostered a number of back-up listed companies which have received policy support or economic subsidy. It can be found out in the current local policies, enterprises going public will receive a fiscal subsidy of from RMB 1 million to 2 millions in batches, which more or less help reduce the cost of corporate financing.   
 
 

Contact Us
Contact Us
*Name:
*Company Name:
*Province:
*City:
*Phone Number:
*E-mail:
*Summary of the Case:
*Captcha: