The well-trodden path

A Chinese company looking to incorporate offshore has a wide range of locations to choose from. The Cayman Islands, Bermuda, the British Virgin Islands (BVI), Jersey, the Seychelles and Mauritius are among the best-known jurisdictions. Tax-friendly policies and corporate structures designed to facilitate stock market listings mean these jurisdictions are favored by venture capitalists seeking easy ways to cash in on their investments.

Follow the leader

Here’s a typical scenario: Investors want a Chinese company to list overseas, so they set up a special-purpose vehicle (SPV) in an offshore location, and restructure the firm’s domestic operations into a wholly foreign-owned enterprise in which the SPV has a majority stake.

Profits are paid to the SPV through dividends issued in the local currency of the offshore location. Under local regulations this income is untaxed. If and when the company does a share offering, the listed entity is the SPV. This means any early backers of the company who now want to exit are able realize their investments in a fully convertible currency.

When choosing an offshore jurisdiction, familiarity is a powerful draw for venture capitalists, and no place is now as familiar as the Cayman Islands. Since the enactment of the Companies Law in the 1960s, more than 80,000 companies have been passed under the pen of the country’s registrar. The islands were the jurisdiction of choice when China’s tech firms first started listing on NASDAQ and are still very popular.

“In the early 2000s, the Caymans were easier and more credible than Bermuda or BVI,” said Derek Sulger, a co-founder of wireless firm Linktone, which incorporated in the Caymans before listing on NASDAQ in 2004.

Sulger, who now runs a private equity firm, admits there is a herd mentality as Chinese firms with big ambitions follow the tried and tested paths used by earlier successful listings. But he believes this faith is well-founded, given the experience Caymans law firms have dealing with Chinese companies.

As of mid-May, half of NASDAQ’s 60 Chinese member companies were incorporated in the Caymans. Twenty were US-registered and five came from the BVI. Over at the New York Stock Exchange, the Caymans accounted for 22 of the 41 Chinese member companies compared to just two from BVI. Bermuda and Singapore are the locations of choice for firms listed on the Singapore Stock Exchange, while Hong Kong-listed red-chip companies opt for the Caymans, Bermuda or Hong Kong.

The Hong Kong factor

Although the Hong Kong Stock Exchange is now making efforts to promote itself to a wide variety of nations, for many years it gave precedence to companies from the Caymans, Bermuda, Hong Kong and mainland China. Obviously, this influenced where companies chose to incorporate.

“When companies form their offshore structure they are at an early stage in their business development. They have not decided where to list and do not want to rule out Hong Kong,” said Catherine Morgan, managing director of CIA China, a company that specializes in offshore incorporation.

That said, certain jurisdictions are chosen for specific reasons. According to Morgan, CIA China sets up five BVI entities for every one Caymans entity because investors like to hold their shares in a listed Caymans company through a BVI holding company. Meanwhile, Hong Kong is expected to attract more offshore incorporations by virtue of its double-taxation agreement with the mainland and the Seychelles hopes to challenge BVI by offering corporate services at lower prices.

However, it remains to be seen if the ruling order can be altered.

“The reality is that no one has made any headway and broken the Caymans and BVI stranglehold,” said Greg Knowles, a partner at Maples & Calder, one of the world’s largest offshore law firms. “Other jurisdictions may have the same kind of legal systems but they don’t have the same scale of infrastructure to support it.”