PE investors should know contractual restrictions before trading
December 14, 2010 | BY
Janice QuNew regulations allow trading of private equity funds
hile a new trading platform might provide some advantages, private equity (PE) investors still need to be aware of contractual restrictions placed on areas such as transfer of shares, transaction structure and valuation, say counsel.
China has announced a new policy governing the trading of PE funds with the Beijing Financial Assets Exchange (BFAE). This is the first regulation on PE fund trading and appoints the BFAE as the first and only market for PE funds and projects in the country.
The Beijing Financial Assets Exchange Private Equity Fund Trading Regulations sets out provisions on trading conduct and the protection of each party's “legitimate rights and interests”. It opens up a new exit route for PE investors, in addition to the traditional exits of initial public offerings (IPOs), M&A and buy-back.
Dafei Chen of Han Kun Law Offices emphasises that investors have to be wary of certain contractual restrictions when considering trading funds.
“Transfer restrictions in the original investment documents, transaction structure, valuation and tax are the key areas that a potential trader at the BFAE needs to watch out for when considering a transaction,” said the Beijing-based partner.
In particular, he illustrated the contractual restrictions on the transfer of equity shares, which might place limits on the sale of equity. These constraints include to whom the fund is allowed to sell to, or requiring consent before the transfer of the founder's shares. “That is why due diligence is of vital importance,” he added.
However, compared to IPOs or M&A transactions, trading on the BFAE could possibly be more efficient.
“IPOs take a relatively longer time to complete and are subject to the impact of the international capital markets,” said Chen. “Sellers and purchasers do not have to go through complicated procedures in the stock exchange market and could possibly fulfill the demand for liquidity on the BFAE in a shorter period of time.”
He notes that PE funds can maintain their private status if trading on the BFAE and believes that the focus of the regulation is on the equity interest of private companies.
Commentators also note that in order to expand the scope of trading parties on the BFAE, it needs to have an effective valuation mechanism and related support services such as auditing, tax structuring, and valuation assessment.
Some market observers say that private equity funds are more likely to participate in the BFAE than venture capital funds, which tend to opt for riskier means with higher returns. It is generally believed that it will take a while before the trading volume on the BFAE reaches a significant level for this new platform.
BFAE rules are not public and available only to trading parties and member companies.
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