15 July 2011
The HKEx (the Exchange) issued listing decision LD15-2011 (the Listing Decision) in relation to whether the Interim Guidance on Pre-IPO Investments (the Interim Guidance) applied to an issue of shares upon exercise of warrants which formed an integral part of a loan agreement between the warrantholder and a company (the Company) proposed to be listed on the Exchange.
and the Interim Guidance can be found at
Set out below is a brief summary of the pre-IPO investment, the Listing Decision, and possible alternative structures for pre-IPO investments in light of the Listing Decision.
The Interim Guidance
The Interim Guidance provides that pre-IPO investments must be completed either (a) at least 28 clear days before the date of the first submission of the first listing application form; or (b) 180 clear days before the first day of trading of the applicant's securities, except in very exceptional circumstances. Pre-IPO investments are considered completed when the funds are irrevocably settled and received by the applicant.
Facts - the pre-IPO investment
The pre-IPO investment in question (the Transaction) was a loan plus warrants investment. Under the Transaction, the Company entered into a loan agreement (the Loan Agreement) with pre-IPO investors (the Investors). As a condition precedent to drawdown of the loan under the Loan Agreement, the controlling shareholder of the Company (the Controlling Shareholder) issued warrants A and warrants B (together, the Warrants) to the Investors.
The Warrants allowed the Investors to acquire in aggregate up to approximately 13 per cent. of the Company's enlarged share capital, and were mandatorily exercisable upon the occurrence of a qualifying IPO. Under the warrants A, the Investors had to pay an exercise price for the shares; under warrants B, the Investors would receive the shares for free. The Investors could opt for physical settlement (by way of delivery of shares in the Company by the Controlling Shareholder) or cash settlement (by way of payment of cash by the Controlling Shareholder).
In compliance with the Interim Guidance, the loan was advanced and the loan proceeds were irrevocably received by the Company, 28 clear days prior to the Company submitting its listing application. However, the Warrants remained exercisable on such date.
The Listing Decision
The Exchange considered that (a) the loan and the Warrants were separate transactions, even though the issue of the Warrants was a condition precedent to drawdown of the loan under the Loan Agreement; (b) the Warrants constituted a pre-IPO investment under the scope of the Interim Guidance; and (c) the advance of the loan was not a settlement of the consideration for the Company's shares under the Warrants. On the basis of the above, the Exchange concluded that the Investors had not complied with the Interim Guidance.
As we understand, the Exchange's key concern was that payment of the exercise price under the Warrants would constitute an injection of capital and, as a result, the Warrants themselves should be considered a separate pre-IPO investment, notwithstanding arguments that (i) the loan and the Warrants should be considered (and commercially are) one transaction as a whole; and (ii) the advance of the loan under the Loan Agreement constituted settlement of the consideration for the shares under the Warrants.
Based on the above, pre-IPO investments that involve any form of capital injection (irrespective of the amount of capital injection or whether the injection is part of the economic return on the pre-IPO investment) would, in the Exchange's view, contravene the timing requirements under the Interim Guidance.
It is important to keep this in mind when structuring pre-IPO investments, in particular loan plus warrant structures. Pre-IPO investments could be structured such that there would be no injection of capital on acquisition or issuance of shares. This could mean adopting structures such as exchangeable or convertible loans or notes. There has been at least one instance post-publication of the Interim Guidance (China Kingstone, stock code 1380) where the Exchange has approved an IPO with a pre-IPO investment in the form of exchangeable notes.
There has also been at least one instance post-publication of the Interim Guidance (Xiangyu Dredging, stock code 871) where the Exchange has approved an IPO with a pre-IPO investment in the form of debt plus warrants, where the exercise price under the warrants were offset against repayment of the debt. This demonstrates clearly that the Exchange is considering each pre-IPO investment on a case-by-case basis, and that different features of a pre-IPO investment could have an impact on the Exchange's view as to whether such investment complies with the Interim Guidance. Given such circumstances, prior consultation with the Exchange on the structure and relevant features of a pre-IPO investment would be advisable.