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HOME > Publications > Professional Articles > Key points to secure corporate compliance in equity financing

Key points to secure corporate compliance in equity financing

Author: Shen Guoquan、Zhang Zhixue 2014-07-19923
[Summary]From the establishment to the termination of a company, and at the production and sales stages, compliant operation is a mandatory requirement. However, the key points of compliance in different economic activities are not identical. In corporate equity financing, the key points requiring attention mainly include the following.

From the establishment to the termination of a company, and at the production and sales stages, compliant operation is a mandatory requirement. However, the key points of compliance in different economic activities are not identical. In corporate equity financing, the key points requiring attention mainly include the following.

Universal key points

Form of equity. There are two principal ways in which an investor can secure equity in a company: (1) subscription for an increase in the company’s registered capital; or (2) acquisition or bequeathal of equity held by an existing shareholder.

With respect to the first method, the investor has the obligation of making a genuine capital contribution in full. In practice, such problems as still pending capital verification, failure to pay in full on time, overly high appraised value of non-monetary assets, registration of transfer of title to capital contribution not carried out, etc., characterise some companies. Notwithstanding the fact that the Company Law has established the registered capital subscription system, an investor is nonetheless required to pay in its capital contribution in accordance with the law and the company’s articles of association.

With respect to the second method, the focus of attention falls on the qualifications to be a party, the capacity to act of the transferor and transferee, and the transaction process.

State-owned enterprises

For example, if the transferor is a state-owned enterprise (SOE), the carrying out of the procedures for an asset appraisal, recordal, title transaction, etc., in respect of a transfer of state-owned equity is normally required, and the compliance of such procedures is of great importance.

If the transferee is a foreign investor, the foci of attention are the industry access restrictions and the examination and approval procedure; for a company that is invested in by a professional investment institution, attention will fall on the additional conditions to which equity investment is subject, e.g. whether there are “redemption” clauses, valuation adjustment clauses, etc.

Corporate governance. The compliant operation of a company includes observation of external laws and norms, as well as internal rules and regulations. If little importance is attached to compliance in corporate governance, such rights of investors as the right to know, the right to decide, the right to scrutinise, etc., will be harmed and the validity of company decisions will be exposed to legal risks. The Company Law specifies that “a resolution of the shareholders’ meeting, shareholders’ general meeting or board of directors of a company that violates laws or administrative statutes shall be invalid. If the procedure for convening or the method of voting at a shareholders’ meeting, shareholders’ general meeting or meeting of the board of directors violates laws, administrative regulations or the company’s articles of association, or if the substance of a resolution breaches the company’s articles of association, a shareholder may request that the people’s court revoke the same within 60 days from the date of adoption of the resolution”.

Focus of attention

Production (service) qualifications. A company seeking equity financing will normally have the qualifications to carry on production and operations. Nevertheless, production (service) qualifications that have been secured, and the issues that will continue to be the focus of attention, include: compliance in the securing of such qualifications (whether they were secured through the submission of fraudulent documents); the conditions necessary for maintaining these qualifications (many qualifications are subject to annual inspection or reporting); the possibility of renewing these qualifications; whether operations have been carried out in a manner that exceeds the qualifications; and whether there is a risk of the qualifications being revoked.

Connected transactions. Connected transactions do not in themselves violate the law. However, a connected transaction can result in a transfer of benefits between the company and connected persons, and whether a transaction is conducted at arm’s length will have a direct impact on the accuracy of the results reflected in the company’s financial statements and directly affect the rights and interests of the company and the unconnected investors of the company.

The Company Law specifies that “a company’s controlling shareholder, actual controller, directors, supervisors or senior officers may not use their connected relationship to harm the interests of the company”. In addition to that, in equity financing, whether there is a deliberate funnelling of benefits to fraudulently pad profits will also be a focus of attention.

Payment of taxes. Paying taxes in accordance with the law includes registering, filing, paying, etc., in accordance with the law. The points of attention on compliance in equity financing include whether the company has evaded, or is in arrears in the payment of, taxes, whether it is required to pay back taxes, whether it has performed its withholding obligations, whether the tax rates and tax types implemented by the company are in compliance with the criteria, etc.

A company must satisfy the relevant conditions when applying for a tax break. For example, a high- or new tech enterprise is eligible for tax breaks, however, if it is found not to satisfy the relevant conditions, its qualifications for the tax breaks will be revoked and it will face the risk of being required to pay back taxes.

Employment. Lawful recruitment, employment, dismissal and payment of remuneration are the basic requirements of employment compliance. In the course of equity financing, whether social insurance premiums have been paid and contributions made to the housing fund are also key points of attention. Failure to pay in accordance with regulations constitutes a liability toward employees, affects the true level of a company’s performance and also exposes it to the risk of administrative penalties.

Furthermore, in accordance with regulations, an employer may only use temporary employees in temporary or support positions or for the temporary replacement of a full-time employee. Acompany using temporary placement as its principal means of employment will be required to rectify this situation.

Specific issues

When coming to the specifics of different companies, there are additionally and different key points requiring attention. For example, with regards to a production-type enterprise, environmental compliance is a key issue.

On the whole, attention to compliance revolves around the following issues: the stability of a company’s equity; continuity in the company’s production and sales; and the contingent risks of the benefits flowing out of the company.

Shen Guoquan is a senior partner and Zhang Zhixue is a lawyer at AllBright Law Offices