Viewpoint | Gambling Agreement "Past and Present"
Published:
2021-12-09
Foreword According to the definition of the "Jiumin Minutes", a gambling agreement refers to an agreement designed to solve the uncertainty, information asymmetry and agency cost of the target company's future development between the investor and the financier when they reach an equity financing agreement. It includes equity repurchase, monetary compensation and other adjustments to the valuation of the target company in the future. It is essentially an option. Since Mengniu Dairy signed the first domestic gambling agreement with investment institutions such as Morgan Stanley in 2003, this equity financing method has become a popular method of financing for Chinese companies, but there are frequent debates about the origin of the gambling agreement. The purpose of this paper is to trace the gambling agreement and briefly analyze its localization rules. The origin of the 1.-to-gambling agreement. China's commonly known as the gambling agreement, also known as the valuation adjustment agreement (Valuation Adjustment Mechanism, "VAM"). Perhaps because the domestic first seen in the investment agreements of foreign investment institutions such as Morgan Stanley, the domestic view of gambling agreements is a common means of financing overseas. However, in the overseas literature database, there are few related articles and cases Valuation Adjustment Mechanism, and most of them are created by domestic scholars and law firms. At the same time, as cross-border investment and financing become more mature, many people recognize that gambling agreements are localized innovations made by foreign investment institutions for domestic companies based on profitability payment plan clauses, anti-ratchet clauses, etc. The offshore financing provisions related to this, while similar in appearance, are quite different in nature. (I) Profitability Payment Plan Terms Profitability payment plan, that is, the earn out clause, refers to the process of financing mergers and acquisitions, the transaction price reached by both parties according to the seller's enterprise's profitability and other ability to float, that is, in the process of mergers and acquisitions, the target company's future earnings, cash flow and other financial indicators as the premise, set up a phased, hierarchical capital injection. A simple model is: The parties enter into a financing or merger agreement, 1. Pay 1 million yuan in cash when the agreement is reached; 2. Within 1 year after the agreement is reached, if the seller's revenue exceeds 700000 yuan, the buyer will pay 1 million yuan for the second payment, and if it does not exceed 700000 yuan, the buyer will pay 500000 yuan; 3. In the second year of the agreement, if the seller's revenue exceeds 1 million yuan, the buyer will pay 500000 yuan for the third payment, and if it does not exceed 1 million yuan, the buyer will not pay the third financing. The profitability payment plan is significantly different from the gambling agreement. Profitability payment plans are where the buyer delays payment to the seller, so they are mostly used for corporate mergers and acquisitions, while gambling agreements are where the investor provides financing to the founder and then requires the founder to buy back the shares or return the financing after the agreed conditions are fulfilled. Types of domestic gambling agreements in (II) 1. Compensatory gambling Compensation is the requirement that the founder compensate the investor for the expected return on investment according to a certain formula after the conditions of the bet have been fulfilled, but the investor's share in the business itself will not be reduced. Compensation can be in the form of cash or equity. The former reduces the investor's risk exposure to the business and realizes part of the investment income when you get cash, while the latter increases the investor's risk exposure to the business, and the volatility of investor returns is more closely linked to the business performance of the business. Although the investor in the compensatory gambling agreement does not withdraw from the financier's company, the cash compensation clause will affect the company's cash flow and damage the partnership between the investor and the financier. The investor's legacy equity may not work, so cash compensation often appears with exit redemption clauses. 2. Redemption gambling. The founder redeems the shares to the investor at a certain price after the conditions of the bet are fulfilled. This is also the most common domestic gambling agreement. Equity redemption is a mature path for PE exit, and most of the domestic equity redemption requires the founder to redeem at a premium, which undoubtedly increases the expected return of investors. Redemption rights are regulated in all countries and are gradually opening up, provided that the capital of the enterprise is maintained. 3. Other types of gambling agreements In addition to the two common types of bets mentioned above, there are equity dilution and equity priority. The former requires that when the conditions of the bet are fulfilled, the financier issues a portion of the shares to the investor at a very low price, while the latter requires that when the conditions of the bet are fulfilled, the financier acquires specific rights such as the right to preferential distribution of the remaining property. In contrast, there are also, but rarely, situations in which the investor rewards the financier additionally when the gambling conditions are fulfilled. 2. the rules of the gambling agreement. (I) the main body of our gambling agreement. One of the parties to the gambling agreement is the investor. This investor is mostly a financial investor, I .e., for the purpose of financial gain and generally does not interfere with the company's operations. The other party may be the target company, the target company's shareholders or actual controllers, and the target company's management. However, because China is still under the statutory capital system of shareholder centralism, management can not properly handle the company's equity affairs in a timely manner, so the gamblers are mostly the first two situations. However, in cross-border investment and financing mergers and acquisitions, the management of foreign companies is very independent. On the one hand, they are the people who best understand the actual value and potential of the company, and on the other hand, the interests of management and shareholders are often not aligned. Although the management of domestic enterprises is still in the stage of subsidiary to shareholders, with the increasing maturity of the business environment, its independence will be greatly enhanced. Therefore, both investors and shareholders must not ignore management's views on the gambling agreement. (II) the validity of our gambling agreement. According to the relevant provisions of the Ninth Minute, the validity of the gambling agreement varies depending on the subject of the gambling party. The gambling agreement signed between the investor and the shareholder or actual controller of the target company shall be deemed valid and support the actual performance if there is no other invalid cause. In the case of a gambling agreement between the investor and the target company, the shareholders, who are required to comply with Article 35 of the Companies Act, may not withdraw their capital contributions. For monetary compensation-type gambling agreements, the order of profit distribution shall be in accordance with Article 166 of the Company Law, and for equity repurchase-type gambling agreements, the procedures of Article 142 of the Company Law shall be followed to complete the capital reduction procedures. In addition, foreign-related gambling agreements often require the approval of foreign investment departments, and those without approval also have the legal risk of invalidity. (III) the legal risk of China's gambling agreement. The first is the listing risk. In September this year, the CSRC called for the listing of many enterprises with gambling agreements to be suspended. The move is intended to further regulate the disclosure requirements of gambling agreements. Generally speaking, the issuer is required to clean up the gambling agreement before filing, and the conditions for exemption from liquidation are very stringent, so it is best to set up the subject of the gambling agreement as the shareholder or actual controller of the target company, so as not to affect the operating ability of the target company's equity structure. The second is the risk of the company's ability to operate. China's high pressure on gambling agreements often requires the company's shareholders and management to have a very clear understanding of the company's ability to operate and future business strategy, otherwise there may be a company's cash flow fracture, loss of control and even inability to repay and other major risks. Therefore, it is very important to set up a reasonable gambling structure and determine the rights and obligations of both parties, so as to prevent angel investors from turning into "barbarians" at the door ". Conclusion Financing has always been an important issue that enterprises cannot avoid. The original intention of venture capital should be to help start-ups turn ideas into products, quickly put them on the market, and then iterate and upgrade products based on user feedback, which is a process of constant "trial and error. As a form of financing, the cost of failure is too harsh to make the gambling agreement quite unfriendly to the financier, but in China's current buyer-led capital market system, the gambling agreement is so popular there is a reason. Therefore, it is necessary to pay attention to its legal risks, use the financing function of the gambling agreement for development and innovation, use its exit mechanism as a driving force, and make good use of this double-edged sword.
Foreword
According to the definition of the "Jiumin Minutes", a gambling agreement refers to an agreement designed to solve the uncertainty, information asymmetry and agency cost of the target company's future development between the investor and the financier when they reach an equity financing agreement. It includes equity repurchase, monetary compensation and other adjustments to the valuation of the target company in the future. It is essentially an option. Since Mengniu Dairy signed the first domestic gambling agreement with investment institutions such as Morgan Stanley in 2003, this equity financing method has become a popular method of financing for Chinese companies, but there are frequent debates about the origin of the gambling agreement. The purpose of this paper is to trace the gambling agreement and briefly analyze its localization rules.
The origin of the 1.-to-gambling agreement.
China's commonly known as the gambling agreement, also known as the valuation adjustment agreement (Valuation Adjustment Mechanism, "VAM"). Perhaps because the domestic first seen in the investment agreements of foreign investment institutions such as Morgan Stanley, the domestic view of gambling agreements is a common means of financing overseas. However, in the overseas literature database, there are few related articles and cases Valuation Adjustment Mechanism, and most of them are created by domestic scholars and law firms. At the same time, as cross-border investment and financing become more mature, many people recognize that gambling agreements are localized innovations made by foreign investment institutions for domestic companies based on profitability payment plan clauses, anti-ratchet clauses, etc. The offshore financing provisions related to this, while similar in appearance, are quite different in nature.
(I) Profitability Payment Plan Terms
Profitability payment plan, that is, the earn out clause, refers to the process of financing mergers and acquisitions, the transaction price reached by both parties according to the seller's enterprise's profitability and other ability to float, that is, in the process of mergers and acquisitions, the target company's future earnings, cash flow and other financial indicators as the premise, set up a phased, hierarchical capital injection. A simple model is:
The parties enter into a financing or merger agreement,
1. Pay 1 million yuan in cash when the agreement is reached;
2. Within 1 year after the agreement is reached, if the seller's revenue exceeds 700000 yuan, the buyer will pay 1 million yuan for the second payment, and if it does not exceed 700000 yuan, the buyer will pay 500000 yuan;
3. In the second year of the agreement, if the seller's revenue exceeds 1 million yuan, the buyer will pay 500000 yuan for the third payment, and if it does not exceed 1 million yuan, the buyer will not pay the third financing.
The profitability payment plan is significantly different from the gambling agreement. Profitability payment plans are where the buyer delays payment to the seller, so they are mostly used for corporate mergers and acquisitions, while gambling agreements are where the investor provides financing to the founder and then requires the founder to buy back the shares or return the financing after the agreed conditions are fulfilled.
Types of domestic gambling agreements in (II)
1. Compensatory gambling
Compensation is the requirement that the founder compensate the investor for the expected return on investment according to a certain formula after the conditions of the bet have been fulfilled, but the investor's share in the business itself will not be reduced. Compensation can be in the form of cash or equity. The former reduces the investor's risk exposure to the business and realizes part of the investment income when you get cash, while the latter increases the investor's risk exposure to the business, and the volatility of investor returns is more closely linked to the business performance of the business. Although the investor in the compensatory gambling agreement does not withdraw from the financier's company, the cash compensation clause will affect the company's cash flow and damage the partnership between the investor and the financier. The investor's legacy equity may not work, so cash compensation often appears with exit redemption clauses.
2. Redemption gambling.
The founder redeems the shares to the investor at a certain price after the conditions of the bet are fulfilled. This is also the most common domestic gambling agreement. Equity redemption is a mature path for PE exit, and most of the domestic equity redemption requires the founder to redeem at a premium, which undoubtedly increases the expected return of investors. Redemption rights are regulated in all countries and are gradually opening up, provided that the capital of the enterprise is maintained.
3. Other types of gambling agreements
In addition to the two common types of bets mentioned above, there are equity dilution and equity priority. The former requires that when the conditions of the bet are fulfilled, the financier issues a portion of the shares to the investor at a very low price, while the latter requires that when the conditions of the bet are fulfilled, the financier acquires specific rights such as the right to preferential distribution of the remaining property. In contrast, there are also, but rarely, situations in which the investor rewards the financier additionally when the gambling conditions are fulfilled.
2. the rules of the gambling agreement.
(I) the main body of our gambling agreement.
One of the parties to the gambling agreement is the investor. This investor is mostly a financial investor, I .e., for the purpose of financial gain and generally does not interfere with the company's operations. The other party may be the target company, the target company's shareholders or actual controllers, and the target company's management. However, because China is still under the statutory capital system of shareholder centralism, management can not properly handle the company's equity affairs in a timely manner, so the gamblers are mostly the first two situations. However, in cross-border investment and financing mergers and acquisitions, the management of foreign companies is very independent. On the one hand, they are the people who best understand the actual value and potential of the company, and on the other hand, the interests of management and shareholders are often not aligned. Although the management of domestic enterprises is still in the stage of subsidiary to shareholders, with the increasing maturity of the business environment, its independence will be greatly enhanced. Therefore, both investors and shareholders must not ignore management's views on the gambling agreement.
(II) the validity of our gambling agreement.
According to the relevant provisions of the Ninth Minute, the validity of the gambling agreement varies depending on the subject of the gambling party. The gambling agreement signed between the investor and the shareholder or actual controller of the target company shall be deemed valid and support the actual performance if there is no other invalid cause. In the case of a gambling agreement between the investor and the target company, the shareholders, who are required to comply with Article 35 of the Companies Act, may not withdraw their capital contributions. For monetary compensation-type gambling agreements, the order of profit distribution shall be in accordance with Article 166 of the Company Law, and for equity repurchase-type gambling agreements, the procedures of Article 142 of the Company Law shall be followed to complete the capital reduction procedures. In addition, foreign-related gambling agreements often require the approval of foreign investment departments, and those without approval also have the legal risk of invalidity.
(III) the legal risk of China's gambling agreement.
The first is the listing risk. In September this year, the CSRC called for the listing of many enterprises with gambling agreements to be suspended. The move is intended to further regulate the disclosure requirements of gambling agreements. Generally speaking, the issuer is required to clean up the gambling agreement before filing, and the conditions for exemption from liquidation are very stringent, so it is best to set up the subject of the gambling agreement as the shareholder or actual controller of the target company, so as not to affect the operating ability of the target company's equity structure. The second is the risk of the company's ability to operate. China's high pressure on gambling agreements often requires the company's shareholders and management to have a very clear understanding of the company's ability to operate and future business strategy, otherwise there may be a company's cash flow fracture, loss of control and even inability to repay and other major risks. Therefore, it is very important to set up a reasonable gambling structure and determine the rights and obligations of both parties, so as to prevent angel investors from turning into "barbarians" at the door ".
Conclusion
Financing has always been an important issue that enterprises cannot avoid. The original intention of venture capital should be to help start-ups turn ideas into products, quickly put them on the market, and then iterate and upgrade products based on user feedback, which is a process of constant "trial and error. As a form of financing, the cost of failure is too harsh to make the gambling agreement quite unfriendly to the financier, but in China's current buyer-led capital market system, the gambling agreement is so popular there is a reason. Therefore, it is necessary to pay attention to its legal risks, use the financing function of the gambling agreement for development and innovation, use its exit mechanism as a driving force, and make good use of this double-edged sword.
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