On 30 November 2013, the China Securities Regulatory Commission (“CSRC”) issued the Opinion on Further Promoting the Reform of New Shares Issuance Systems (“Reform Opinions”), which puts forward a series of measures toward its stated end. One of the most important proposals is the transfer of existing shares. According to the Reform Opinion, the existing shareholders of an initial public offering who have held shares for three years are encouraged to offer part of their shares to investors, thereby increasing the proportion of tradable shares of the newly listed company. This enables the issuance of new shares and transfer of existing shares to be conducted simultaneously. On 2 December 2013, the CSRC successively released the Interim Provisions on Public Offering by Shareholders in an Initial Public Offering (“Interim Provisions”), which further specifies that the transfer of existing shares refers to the possibility for existing shareholders to sell their shares through an initial public offering.
“Transfer of existing shares” means the sale of shares held by the original shareholders of a company through an initial public offering so that such shares are then become publicly held. The transfer of existing shares will neither increase the number of issued shares, nor dilute the shareholding ratio of other shareholders. The shareholders who transferred the shares retain the revenue from the sale of shares, not the company. Therefore, such transfers are a means for the original shareholders to reduce their shares through share issuance. The transfer of existing shares mainly involves those shareholders who held shares prior to the IPO, including the original shareholders of the company (including the limited liability company prior to the restructuring into a company limited by shares), sponsors, angel investors, strategic investors and senior managers, among which some may be insiders who hold internal information of the company. Therefore, moral risks may apply to existing-share transfers as a result of information asymmetry.
According to the Reform Opinion, where the number of new shares is insufficient to meet the statutory listing conditions, the issuer may increase the number of shares in public offering by the transfer of existing shares. Where the amount of funds raised in the new share issuance exceeds the statutory requirement, the existing shares shall be reduced correspondingly.
According to the Interim Provisions, where the company issues a secondary offering, it shall satisfy the following requirements:
- Substantive Requirement
- The shares for public offering by shareholders shall be held for more than 36 months.
- The public offering of shares by shareholders will neither cause material change of the shareholding structure nor change the actual controller of the company.
- The ownership of shares for public offering shall be free of any legal dispute, pledge, freeze or other circumstances of non-transfer according to the law.
- The number of newly issued shares shall be reasonably determined based on the amount of requisite funding of the project.
- Procedural Requirement
- Where the shareholder proposes a public share offering, it shall submit an application to the issuer’s board of directors, and obtain approval from competent authorities where such approval is necessary.
- The issuer’s board of directors shall make a resolution on the issuance proposal, and submit it to the shareholders’ meeting for approval.
- Document Requirement
- The share issuance proposal shall set forth the estimate of new shares to be issued, the estimated number and cap for public share offering by relevant shareholders, and the number adjustment mechanism for the issuance of new shares and transfer of existing shares.
- The issuer shall disclose relevant information including the new shares to be issued and the proposed number of shares for public offering by shareholders.
On 30 December, 2013, after 15 months suspension of the A shares market, the first batch of corporations including Guangdong Xinbao Electrical Appliances Holdings Co.,Ltd, Zhejiang Wolwo Bio-Pharmaceutical Co., Ltd., Truking Technology Limited, Neway Valve (Suzhou) Co., Ltd. and Guangdong Qtone Education Co., Ltd. obtained approval from the CSRC for existing share transfers. According to the information publicly disclosed by the aforementioned corporations, all of them have introduced existing share transfers.
Proportional reduction and transfer by the controlling shareholder are major models for existing share transfer proposal.
- Proportional Reduction
Among all proposals for existing share transfer, proportional reduction yields the most desirable results as it is a result of a mutual compromise from the stakeholders. In this model, shareholders of the company shall transfer their shares based on the same proportion and assume the corresponding underwriting charges for such offering of shares.
According to the information disclosed by Zhejiang Wolwo Bio-Pharmaceutical Co., Ltd., the number of issued shares was not more than 300 billion, in which the shares offered by shareholders did not exceed 200 billion. The shareholders including Zhejiang Wolwo Consulting Co., Ltd., Oriental Fortune Capital Co., Ltd., Lehel Capital Co., Ltd. and Dedonghe Capital Co., Ltd. had transferred their shareholding as per the same proportion for public share offering specified in the issuance proposal.
- Transfer by Controlling Shareholders
The shareholding of the actual controlling shareholder for some listing candidates is relatively high, up to 55% or more. Transferring the secondary stocks and reducing the shareholding in an IPO will avoid both raising a lot more money than required, and enable the actual controlling shareholder to cash out. If the share price decreases in the future, the controlling shareholder may reclaim such reduced stock by way of private placement or by increasing the company’s shares.
According to the public disclosure of Guangdong Xinbao Electrical Appliances Holdings Co., Ltd, the proposed issuance number is not more than 76 million shares. Based on the result of a price enquiry, in case that the amount raised by the issuance exceeds the required amount, the company shall reduce the amount of new shares for public offering. If the amount raised by the issuance still exceeds the required amount when the amount of new shares is reduced to 40,666,800, then the amount of new shares for public offering by Donlim Group, the controlling shareholder, shall not be more than 10 million. The total amount of issued shares shall not be more than 76 million.
In addition, according to the information publicly disclosed by Guangdong Qtone Education Co., Ltd., shareholders will reduce the existing shares in the following sequence: external shareholder, directors, supervisors and senior managers who hold stocks of the company, controlling shareholder, actual controller and the holding company controlled by the actual controller.
Transfer of existing shares is common for issuance of shares in more mature, foreign securities markets, and is positive for realizing the basic functions of capital markets and alleviating the pressure on the secondary markets. However, it also offers the opportunity to shareholders of the company to cash out by taking advantage of the initial public offering, which may prejudice the future development of enterprises and even damage the investors’ interests, making the company exposed to certain operational risks. Therefore, despite its advantages, it is necessary to consider how to avoid or resolve such issues in practice.