A law already in effect and an eagerly anticipated regulation could make life better for foreign private equity (PE) and venture capital (VC) funds operating in China.
The first, the Partnership Enterprise Law, was amended in August 2006 and came into effect on June 1 last year. Significantly, it allowed the formation of limited liability partnerships, according to a report by law firm Morrison and Foerster.
This put it in line with the typical US structure of a VC fund, which provides for general partners, who manage the business, and limited partners, who only provide capital and take share in the profits. While general partners are personally liable for the partnership’s debts, the liability of limited partners only covers the capital contributions they made. Partnerships are also exempt from paying income tax. Instead, partners report their share of profits or losses in the company on an individual basis.
The Partnership Law, however, only governs domestic partnerships, although Article 108 states that the State Council will promulgate measures regulating foreign-invested partnerships. The Ministry of Commerce (MOFCOM) then created a draft of the Foreign Investment Partnership Regulations (FIPR) last January. This held out the promise of allowing foreign firms to use the limited liability model for funds in China. [[more]]
“Elsewhere around the world, VC or PE funds go with a [limited partnership] model. If this proposed [rule] finally comes to light, then US investors, VCs, PE players, who are more familiar with the limited partnership model can have their way in China,” said Frances Du, who researches private equity in China at consultancy JL McGregor and Co.
But the FIPR hasn’t been promulgated, despite early predictions in the investment community that it would be approved at the end of last year. Additionally, it makes no mention of key areas of concern for foreign funds, Morrison and Foerster said.
For most foreign PE players, it is a case of wait-and-see, although some are already keen to set up joint venture funds with local firms. According to Maurice Hoo, a partner in the Asia private equity group at law firm Paul Hastings, there are two forces driving this.
“First of all, foreigners are much more comfortable with the idea of holding renminbi-denominated assets than they once were,” Hoo said. “[And secondly], there was the change in merger and acquisition rules in August 2006, which makes it harder for foreigners to invest in Chinese firms through offshore holding entities and then guide these firms to overseas listings.”
There is also the perception that it is easier for onshore funds to get deals approved. However, Hoo notes that there are two kinds of onshore fund – those that are purely domestic and those that, although formed under Chinese law, have foreign investors.
“Investments by the purely domestic funds don’t require MOFCOM approval, while investments by the foreign-invested funds still need approvals as they are still considered ‘foreign’ in many respects,” Hoo said.
He accepts that, in the long-run, onshore funds may find it easier to get approvals than their offshore bretheren but argues that it is still too early to say for sure.