Under Article 125.2(b) of the Enterprise Law 2020, except for the cases of merger and consolidation of companies, when a non-public joint stock company (a target company) plans to conduct a private placement of shares, the existing shareholders must be offered to purchase such shares first. Only after the existing shareholders do not subscribe for new shares, the target company could conduct a private placement of shares. While the new regulations clarify an unclear point before the Enterprise Law 2020, they could increase the risks that a target company may not be able to successfully issue shares to a desirable investor via a private placement. Below are some potential mechanism to mitigate such risks.
Obtaining waiver of pre-emptive right of existing shareholders
Under this option, before completing the private placement, the target company will request each existing shareholder to waive pre-emptive right to subscribe new shares to be issued to the prospective investor.
This option may be subject to the following issues:
The existing shareholders may refuse to give the required waiver; and
If an existing shareholder has given its waiver but later on transfer its shares to a third party prior to the private placement, then the transferees may withdraw the waiver or may deny to be bound by the waiver given by the selling shareholder. To reduce this risk, the company may have to request the existing shareholders to include undertaking in the waiver that when existing shareholders transfer shares, its transferees will also comply with the waiver.
Offering shares to existing shareholders with terms and conditions that only prospective investors are satisfied
Under this option, the Board of Directors (Board) of the target will pass a resolution to offer of shares to the existing shareholders with terms and conditions which are only satisfied by the prospective investors (e.g. technical/work experience requirements; shares must be paid by non-cash consideration; etc.,). Technically, the Board could do so since Article 126 of the Enterprise Law 2020 provides that the Board has the authority to decide on the timing, manner, and price of shares issued by the company.
If the existing shareholders want to exercise their pre-emptive rights to subscribe new shares, they must accept the offer as a whole and it is likely that no existing shareholders could satisfy all specific conditions as to be offered to the prospective investors. For example, if the Board requires shares to be paid by certain non-cash consideration then there is nothing at law which allowing existing shareholder to pay such shares by cash. Accordingly, pursuant to Article 125.2(c) of the Enterprise Law 2020, the Board could issue new shares to the investors on the ground that no existing shareholders have accepted the offer specified under the Board’s resolution.
However, this option is also subject to the risks as below:
The existing shareholders may transfer their pre-emptive rights to other parties who can satisfy conditions for subscribing new shares but are not the prospective investors;
The existing shareholders could challenge the Board’s offer on the ground that they are treated unfairly (since the Board is well aware that the existing shareholders cannot satisfy specific conditions attached to the offer). To mitigate this risk, the offer may need to be approved by the GSM instead of the Board; and
This option may not work for financial investors.