How PE Investors Can Avoid Pitfalls When Investing in PRC-Related Deals

Summary

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• Much has changed in the PRC's investment market for private equity investors since before the pandemic, but much also remains the same
• Recent MIIT rules provide much anticipated clarity over what is or is not permitted in the PRC's promising and valuable Internet ecosystem
• In its implementation of the PRC's offshore IPO rules since March 2023, the CSRC has also provided clarity over what types of structures and listing venues are and are not allowed
• Ask yourself – if the clarity we have now existed five years ago, would we still have invested in the PRC market? If the answer is still yes, there are ways to minimize legal risk in this new normal

The current market for private equity investors investing in PRC related transactions is, in many respects, virtually indistinguishable from the market immediately before the pandemic. Since the beginning of 2022, there have been just two IPOs of PRC companies on U.S. stock exchanges which raised over $100 million. In Hesai's case, it listed right before the effective date of the new offshore IPO rules of the China Securities and Regulatory Commission (CSRC). In Zeekr's case, it was a spin-off from Geely and not a stand-alone business with a typical red-ship structure. Plus, Zeekr operates in a geopolitically sensitive area (electric vehicles), and listed just days before the U.S. increased tariffs on the import of electric vehicles from the PRC from 27.5% to 102.5%. Since the implementation of the offshore IPO rules by the CSRC, the variable interest entity (VIE) structure has been intensely scrutinized, M&A exits are still relatively in their infancy compared to other jurisdictions, U.S.-China geopolitical tensions have worsened, and the Hong Kong IPO market has only recently recovered with significant IPOs.

However, much remains the same. According to International Monetary Fund forecasts, the PRC will account for 21.2% of the world's growth in the next five years, which is ahead of the U.S. at 11.9% and India at 14.1%. According to a 2023 study by the Australian Strategic Policy Institute (that was funded by the United States Department of State), the PRC leads in research in 37 of 44 critical and emerging technologies. PRC companies in various industries, from technology (such as Mobvoi) to ChaPanda (a tea chain) have recently completed over $100 million-worth of offerings on the Hong Kong stock exchange, providing exit opportunities for investors. Furthermore, there is now legal clarity on previously unclear items, such as what sectors are and are not permitted for non-PRC investment.