CHINA Trends and Developments Contributed by: Richard Guo, Zhen Chen, Zhiyi Ren and Sherman Deng, Fangda Partners
The Guiding Opinions and other central and local poli - cies aim to relax regulation on the guidance funds in various ways. Local governments are translating the Guiding Opinions into operational rules. One focus is to promote investment in VC funds, with an emphasis on portfolio investments in early-stage, small-scale and long-term hard technology companies. Govern - mental guidance funds are encouraged to increase their contribution ratio to, and relax their limits on, fund terms of investee VC funds. The performance of inves - tee funds is to be evaluated overall, rather than based on returns of a single project or a single fiscal year. The return investment requirements can be relieved or eliminated, and the governmental guidance funds are encouraged to have other purposes than purely attracting investments to local areas. Cross-regional vehicles that pool fiscal resources from multiple gov - ernment platforms under one market-oriented GP have gained traction, avoiding duplicative structures and improving project selection and post-investment execution. The common objective is to perform the function of patient capital – ie, to be stabilising fund - ing for the investee funds and portfolio companies without interfering in their day-to-day operations. The Growth of Secondary Market and S Funds As the first batch of RMB funds have approached the end of their terms and IPO windows have become selective for portfolio companies, secondary trans - actions and fund restructuring have evolved from ad hoc liquidity generators to established market prac - tice in the RMB fund market. State-owned platforms and governmental guidance funds increasingly spon - sor secondary funds of funds (“S funds”) to add dry powder to existing assets and extend the holding period of selected portfolio investments. Meanwhile, regional OTC equity markets set forth standardised procedures and disclosure frameworks for bulk trans - fers of interests in PE/VC fund – particularly those with significant state-owned LP interests, which reduces the uncertainties in the bidding process, due diligence and state-owned asset transfer approvals in one-on- one fund interest transactions. Among the various forms of secondary transac - tions, GP-led fund restructurings have developed most rapidly. Fund reorganisations, single-asset and multi-asset continuation vehicles, “stapled” transac -
tions and “stripped” transactions – where purchasers of legacy positions also commit to the new vehicles sponsored by the GP – now sit alongside traditional LP-led sales. Certain sponsors have tried GP-led fund restructuring, such as setting up continuation funds to acquire all or part of remaining portfolios of exist - ing funds. S funds and other investors provide new money to the continuation funds, and S funds usually take the lead in the negotiation of fund terms, while investors of existing funds are offered opportunities to participate in the continuation funds. This approach avoids asset-level transfers and the inherent tax and administrative burdens, while extending the holding period of the assets. Investors of existing funds are offered genuine alternatives – ie, cashing out and/or participating in continuation vehicles with enhanced terms. However, “roll-in” is not generally feasible due to obstacles under PRC tax regulations. Secondary transactions usually involve cross-border elements. Offshore S funds and other foreign investors may participate in onshore transactions through QFLP funds, either sponsored by the S funds/foreign inves - tors’ onshore affiliated managers or by the domestic sponsors of onshore continuation funds. Simulta - neously, onshore S funds pursue offshore portfolio investments through outbound investment channels. Further, onshore and offshore joint investment struc - tures – offshore continuation vehicles working in par - allel with onshore RMB funds of new money to invest in the same asset pool – are appearing. In addition to expanding the funding sources, the onshore-offshore joint investment structure allows fund managers to reconcile the currency, duration and corporate gov - ernance requirements appropriate to the invested assets. The Rise of Buyout Funds and Other Investment Structures Policy support and the market’s demand for high- quality restructurings have shifted the focus of funds towards control-oriented transactions, with RMB sponsors increasingly raising buyout funds, particu - larly with commitments from large-scale institutional investors. RMB funds’ emphasis on downstream investments has shifted from passive, short-term minority investments to long-term, value-added investments for control stakes, which may include
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