Controlling risks in stock investment and financing

aAs the country undergoes economic transformation and industrial restructuring, equity investment and financing activity is booming, with active acquisitions particularly in the areas of real estate, culture and tourism, and innovation and technology.

Both equity investments and loans take the form of stock transfers by the target company’s shareholders and are intended to raise development funds, restructure property rights, and optimize resource allocation.

The main difference is whether the acquisition involves direct involvement in the operations and management of the target company.

In stock investment, the investor usually takes the lead or directly participates in management after the stock transfer is completed. Equity financing, on the other hand, focuses on addressing the target company’s financing issues to ensure safe withdrawal of capital.

Companies are exposed to many legal risks in acquisitions, so they need to take early precautions and be mindful of risk management.

This article analyzes the legal risks that acquiring companies need to avoid during the typical acquisition process and when planning equity investments and financing.

legal due diligence

Apart from a detailed routine investigation of the target company, legal due diligence should also address the following risks:

Liabilities and restrictions on the rights to the stock or material assets of major related parties; This refers to a situation where the target company has outstanding bank loans. The Company and its related parties have pledged shares. If the company borrows or lends funds from related parties. or the company’s capital is frozen by court order.

In such cases, a company that has decided to carry out an acquisition may negotiate with the pledgee, such as a bank or other financial institution, to change the shares without changing the pledge or cancel the pledge. There is a possibility of negotiating repayment to replace the pledgor.

Companies may also include such borrowings in their cost of transaction capital or require the target company’s original shareholders to commit not to take any material debt private.

accounts receivable. The main issues that need clarification are the ratio of allowance for doubtful accounts and other receivables, the accounting period, the possibility of an increase in the loss-of-debt rate and the impact on the target company’s valuation. Therefore, it is advisable to make adequate provisions for bad debts. Requiring the target company’s actual managers to provide debt guarantees and establishing early warning and assessment systems for debt collection risks. Readjust the valuation of the target company.

Core technology development and intellectual property rights. For target companies that are capable of independent or joint development of technology, or that outsource the development of intellectual property to third parties, due diligence should be applied to the development and protection of core technology, and the ownership and transfer of intellectual property rights. need to be focused.

In this regard, enterprises should refine and improve relevant contracts to optimize provisions regarding the attribution of intellectual property rights, declaration of patents, results, scientific achievements, transformation of infringement liability, and ensure sound Establishing pre-acquisition risk barriers is recommended.

Non-competitive with core team. Due diligence should also cover labor contracts and non-disclosure agreements signed by core team members, as well as social security payments and non-compete agreements.

If a non-compete agreement has not been concluded, we will require the target company to promptly rectify the situation before the acquisition. The target company must also undertake to bear the liability risk for non-payment of required social security and reserve funds before the transaction, and the actual management must ensure the stability of the original core management and management team. You will be required to sign a pledge for this purpose. There will be no further layoffs. The target company may also consider starting an equity incentive plan after the acquisition.

Involvement in litigation. This area primarily includes litigation-related receivables and payables. Analysis should include the cost and duration of disputed claims, the legal classification of disputed debt, the possibility of debt reduction or stripping, and the impact on the target company’s valuation. The acquirer may insist that the controlling shareholders and effective controllers of the target company are jointly and severally liable for the debt.

Stock transfer agreement

When a company decides to make an acquisition after completing its legal and financial due diligence, drafting a stock transfer agreement is an important next step.

As a legal means of capital management, stock transfers are secure and include reasonable and carefully prepared provisions, with relevant ancillary agreements such as trade secret confidentiality agreements and technology licensing agreements, that serve the interests of all parties. and should be done through enforceable contracts. .

The main provisions of the stock transfer agreement are as follows:

Subject of agreement. The parties to the stock transfer agreement are the shareholders of the acquiring company and the target company. Legal risks related to ineligible transfer targets, capital ambiguity, and inappropriate selection of transfer targets should be avoided. The legality of the identity of the transferring shareholder, the eligibility of the transferee, and whether all parties are eligible to be either transferor or transferee under the law or the company’s articles of association should be checked.

Representations and Warranties. Completely truthful information may not be available through pre-acquisition due diligence. Therefore, with the aim of mitigating the legal risks of false disclosure, related matters should be promised in the stock transfer agreement to ensure the legality of the transaction and facilitate the acquisition.

Please see the Legal Due Diligence section above for specific designs and arrangements.

Asset valuation. To prevent legal risks from inaccurate asset valuations, all types of tangible and intangible assets of the target company should be thoroughly evaluated. In particular, the valuation of intangible assets should include, in addition to intellectual property rights, the target company’s business reputation, operating model, supply and distribution channels, and market potential.

PRICES AND PAYMENTS. Reasonable arrangements should be made to allow for the transfer of shares, specific payment methods and the opening of regulated accounts.

Debt consolidation. This clause should focus on how the target company’s existing, contingent, and hidden liabilities will be assumed, agreeing on the extent, manner, and proportion of the parties’ contribution to the acquisition price.

Jin Wei is a senior partner at DOCVIT Law Firm.